Fundamentals of Life Insurance
Life insurance as a financial product has seven fundamentals in common with all other insurance products. First and foremost everybody with dependants or large financial commitments needs life insurance. Therefore, just like car insurance there are a huge number of customers. The majority or life insurance policies are applied to individuals, again just like cars drivers.
Because the life insurance market is made up of numerous individuals all seeking security, the insurance companies gain from something called, appropriately enough, the “law of large numbers”. This is a probability thing that describes the phenomenon that as numbers grow the actual outcomes increasingly move towards expected outcomes. For life insurance the expected outcomes are that people will survive for the term of the policy as indeed most of the companies clients do.
The second fundamental of insurance is that the loss, death in the case of life insurance, is definite one. There is no mistaking when where and why it takes place.
The third fundamental is that the thing, which leads to the insured loss, death in our case, is outside of the control of the beneficiary. Of course it is not unknown for the very rare beneficiary to control of the loss-triggering event in order to benefit from insurance payout. It is the fascinating stuff of many a movie but an extremely rare occurrence in real life.
The size of the insured loss has to be very significant from the point of view of the insured person. This is the fourth fundamental of insurance. Clearly removing the financial anxiety from dependants in the event of your death is of such significance to most people that life insurance is the second most important financial product to individuals. For the insurance companies the premiums or price paid by their customers needs to cover two things. Firstly the benefits paid out in the event of death and secondly the cost of drawing up and administering the policy. Small losses would are unlikely to make these latter costs economic but this is far from the case with life insurance because it is of such real and significant value to the insured person.
Fundamental number five is affordability. The premium derived from the costs described above must not be so large that nobody will take up the product. Unfortunately this can be become the case in certain car driver situations and leads to some people breaking the law by driving without insurance even though the fundamental of significant loss still applies.
Fundamental six is that the losses from the insured eventuality, death in the case of life insurance, can actually be counted. Another thing needs to be taken into the calculations also and that is the probability of the death happening. From the viewpoint of the customer it is just as important to keep the benefits payable from their policy in line with their potential losses. So for example if they receive a windfall gain and pay down some or even their entire mortgage, then they would be wise to reduce the benefits payable under their life insurance and also their premiums.
Finally, fundamental seven must be that there is a very limited risk of very large catastrophic loss. This is so with life insurance because by nature it is an individual insurance item and the chances of say all Titanic passengers holding insurance with the same company are infinitesimally small.
|
