Am I Covered or Not?
Make sure you understand what you’re buying and what it covers.
If I pay an insurance premium, does that mean I’ll get paid if something goes wrong?
That question is difficult for the average insurance agent as well as the typical insurance consumer to answer.
Understanding some insurance basics—such as covered loss, exclusions, underwriting and the difference between a bond and insurance—will help with the answer.
Bond Versus Insurance
Most consumers do not understand the difference between buying a bond and paying an insurance premium.
The textbook definition of insurance is transferring the risk from the consumer to the insurance company, also known as the carrier. In the case of true insurance, the consumer is out only the premium and possibly a deductible. The carrier will pay the limit of the loss if the loss was a named peril in the policy.
The easiest way to explain this is to use life insurance as an example. If you paid the premium and the policy is in force when you die, your beneficiary gets paid. Yes, in the case of life insurance, the named peril, pure and simple, is death!
Personal (your auto and home) and commercial (business, builder’s risk, E&O) coverage works the same way: You pay a premium and the carrier pays for covered losses if the loss was caused by a named peril. A named peril could be collision, fire, theft, flood, etc.
Bonds do not work in the same way. Bonds are not a transfer of risk. After the purchaser buys a bond by paying the bond premium, the purchaser could be out way more than the premium that was paid. Bonds guarantee a payment of an obligation of the purchaser. However, the bonding company will seek reimbursement.
To illustrate this concept, consider a bail bondsman. Let’s say you party too much and get arrested. The judge sets your bail at a million dollars. You have $1 million in home equity, so a bail bondsman pays about 10% of the $1 million to guarantee that you will show up for trial. When you skip out on your court date, the bail bondsman takes your equity. That is a pretty steep price to pay.
In the real estate world, performance bonds might be used to guarantee work. By now, you can imagine that someone will go after that contractor’s other assets to get paid back if the performance is below the contracted requirements.
Covered Loss
Before going any further, let’s be clear: insurance is never used for speculation. Losses in the insurance world are measurable and accidental in nature.
If there is a 100% certainty that something bad will happen, it is uninsurable.
So, what does insurance cover? Named perils, like theft, fire, flood, etc. A covered loss is simply a loss covered by a named peril. Both commercial and personal policies state named perils. There is not one policy covering all known perils like fire, theft, flood and wind. Typically, a homeowner’s policy covers fire and storm damage; however, those policies exclude wind, flood damage and earth movement, also known as earthquake coverage. If you live in California, consider buying a separate flood and earthquake policy if you have lots of equity in your property. Likewise, if you own mortgaged property in Florida you must have a wind policy for the next hurricane and possibly a flood policy.
Here’s why. Remember Hurricane Sandy? Coney Island was hit hard. Some people bought wind policies. When their roof tops were blown off, that loss was covered in the wind policy. What the residents did not expect was the storm surge that washed over the top of their walls and swept away their home and belongings. Only a flood policy covers mud slides and any water movement above the ground surface.
Exclusions and Underwriting
Combining exclusions and underwriting is easy. Lenders underwrite loans. Insurance agents and brokers underwrite risks.
To properly underwrite insurance, the agent/broker should require you to disclose any material information about your business. Often an insurance company will deny a claim because the applicant or agent never disclosed the information to the company.
If the applicant overdiscloses everything about the property/business, that is not necessarily a bad thing.
The underwriting file will be provided to the carrier. Here are the possible outcomes:
- An issue disclosed to the insurance carrier is listed as an exclusion and not covered.
- The issue is covered by an endorsement/rider (a modification to the base policy) and possibly subject to additional premium.
- The carrier assumes the risk based on everything in the underwriting file. Basically, knowledge and information are power.
Insurance is an actuarial science and has never been “rocket science.” The truth is in the numbers. Consumers, agents/brokers and carriers should all follow the rules of proper disclosure. The best advice: Buy the best insurance you can afford and hope to never use it!
