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Financial Freedom Is Merely Organized Common Sense
Should You Read An Insurance Policy?
Why is an insurance policy 25 pages of not very big print?
There are many reasons, and when you think about it they make some sense. As a policy owner, you want to be paid for your losses and you want to pay the lowest possible premium.
Most of the words in a policy define what is covered and not covered, in considerable detail. That reduces the cost of litigating claims later and it prevents claims from being incentivized.
Let’s look at three underlying thoughts.
Anti-selection. Insurers make it a little difficult to become covered. If life insurance companies did not require a medical, would anyone buy coverage before they fell ill?
The idea of insurance is to pool risks so that none of us need suffer the entire loss.
Pooled risk does not work if people can come and go from the pool at will. The people select to be covered against the interests of the insurer. Suppose your group insurance carrier let you come and go. Better pay this month because the kids are all going to the dentist. Huge premiums would become necessary.
Moral Hazard. You should not do for people the things they should do for themselves. When a person does not have to absorb the risk and consequences of an action they are operating within a moral hazard. For example, bank deposit insurance means that no one assesses the financial stability of a bank prior to making a deposit.
A moral hazard provides no disincentive to behave some, often careless, way. Insurers try to minimize that sort of incentive and the circumstances that they do not cover provides some limit. You cannot collect on life insurance after you murder the insured. You cannot burn your house down for the insurance. In some accidental death insurance policies there is an exception for deaths that were “reasonably foreseeable.” If you decide to climb the CN Tower and fall, the insurer is unlikely to treat your death as accidental.
Risks that cannot be calculated. Insurance mathematics wants to treat each event as unique. If the existence of one event means the likelihood of many more similar ones, then the math tends to not work. An example is declared war. If your home is destroyed by an invading army during a declared war, you are not covered. The insurer would see the probability that in that circumstance, nearly everyone’s home would be destroyed. They know the cost but cannot calculate the probability. So they exclude the risk. The refuse to play option.
Similarly a young person with an inoperable brain aneurism can have a life expectancy of 60 years or 60 seconds and the insurer has no way to know which. So they pass.
You will never know everything you need to know by reading the policy. Suppose my home is destroyed by a terrorist activity, (such activity not defined in the policy.) It might be the result of a declared war, and if it is, I will not be paid. Should I pay attention to government rhetoric like “declared war on global terrorism?”
Maybe.
.
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Don S
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