The Purpose of Insurance
An important topic insurance training covers is the function of an insurance company and the legal construction of an insurance policy. Insurance is a form of ‘risk management’ used to protect the financial well-being of an individual, company, or other entity in the event of unexpected financial loss. While health, life, and disability insurance provides a financial safety net against the unexpected financial loss associated with illness, disability, or death, the goal of an insurance company is to maintain profitability for it’s shareholders.
Some small risks can be managed with personal or company finances; however, larger, more catastrophic expenses are best handled by transferring the risk to an insurance company. The insurer will assume the cost resulting from the insured’s risks, and in exchange, the insurer charges a monthly premium (monthly payment) to the insured. This is accomplished by purchasing an ‘insurance policy.’
An insurance policy is a binding agreement designed to protect against financial loss, and as a legal contract, it reflects the insurer’s responsibilities of covering such loss.
A life insurance policy is designed to pay a stated sum to the designated policy beneficiary in the unlikely event that the insured dies within the policy’s coverage period. A health insurance policy is designed to indemnify an insured for medical treatment in the event of an accident, illness, or disease. And a disability insurance policy is designed to indemnify an insured by replacing lost income during a time of disability. In all cases, Indemnity refers to the insurance proceeds that are paid to the insured or beneficiary in the event of a loss.
The legality of any insurance policy is based on the concept of insurable interest. In other words, in order to obtain insurance, an ‘interest’ must exist between two parties where one party has the potential to suffer a loss in the event that a particular outcome occurs (which was covered by the insurance policy).
Insurable interest occurs between two parties that, upon the loss of one party, the remaining party will have suffered some sort of loss.
Examples of Insurable Interest
- The loss of a loved one, such as a blood relative (spouse, parent, grandparent, children, grandchildren)
- The loss of a business partnership that would result in financial hardship if a key member were to be removed from the business
In contrast to insurable interests, insurance cannot be purchased on strangers, friends, associates of no financial significance, or the like where the potential for gain, instead of loss, were to occur.
When speaking about life insurance, insurable interest must exist at the time of application, but is not required to still exist at the time of an insured’s death.
This determines who may purchase a policy, but does not affect who will benefit from the policy. For instance, if a married couple purchased life insurance on each other and at a later date they divorced, they would still continue to serve as each other’s beneficiary if one were to die, and would still be eligible to collect the contract’s death benefit.