A Little Summer Reading

by Mark Goldwich

At breakfast this morning my kids were talking about going to the library today with their grandma to pick out some books to read over the summer. They talked about some of the books they might get, or even the types of books. Naturally, they wanted to read books that were “fun”, and I thought they should read books that were more educational.  In any event, it got me thinking about books, reading, and school, so I thought I would take this opportunity to write about what I first learned on the subject of insurance in school – which for me would have been in college.

People sometimes ask how I started working in insurance, and when I tell them I graduated from the University of Florida with a Bachelor of Science degree in Insurance, they ask how that happened. It was a bit of a fluke, actually. When I went to register at UF, I met with an administrator who was helping me fill out forms, and she asked what I wanted to major in. I said, “Business”. She said, “OK, so you want to enroll in the Business Administration program, but what about your major?” Again I replied, “Business?” not sure what I had missed the first time around. She then explained, “Business Administration is the college program, but you need to tell me what specific degree you want.” Clearly, I had not put a lot of thought into this, so I gave up on trying to not appear ignorant and replied in defeat, “I don’t know, what are my choices?” She began to quickly rattle off a list as if I wasn’t the only knucklehead who didn’t know what degree he was seeking, “Marketing, Management, Economics, Finance, Insurance, Accounting,…”

“Insurance” I promptly quipped, interrupting her as if I knew this all along. She didn’t need to know I only said this because my dad was an insurance agent, and I had no clue what the others entailed (I didn’t have much of a clue what insurance entailed either, but that was just something else she didn’t need to know, and at least it was a word I recognized). “OK, Insurance it is…and don’t worry, you can change your major at any time” she said as if most people who first choose Insurance end up switching.

And the rest is history.

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But before the rest, came several fairly boring courses on Risk Management and Insurance. And

while I don’t remember a whole lot directly from those classes (it was the 80s, after all), I remember enough to help me understand some key concepts, and to see how insurance has changed over the decades.  Insurance (in one form or another) has been around for a long, long time, since about 2000 BC, and while the policies today are very complex, the basic concept is very simple: Insurance is the transfer of risk of loss from one entity to another in exchange for money. Insurance is a form of risk management.

In life, there are always risks. There is a chance you will get sick, or your property will be damaged, or you will die, etc. For each of these risks, there are really only a few ways to deal with them:

Avoid the risk – just as it sounds, you avoid the activities associated with the risk. If you don’t want to die in a plane crash, you avoid flying. If you don’t want to lose a home to fire or foreclosure, you rent. Avoidance is a fairly certain method of managing risk, but it is not always practical. Also, by avoiding flying to a work conference, you may be more likely to die in a traffic accident. Avoidance is the most effective, but the most extreme method of risk management.

Reduce the risk – this method takes into consideration that you can’t simply avoid everything, so instead you merely seek to reduce the chances of the risk in question. Examples would include doing research to fly on only those airlines with the best safety records, taking better care of yourself in terms of nutrition, sleep and exercise, completing a safe driving course, having working smoke detectors and fire extinguishers in the home.

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Share the risk – this method includes insurance, and involves an agreement to share the loss (or

gain) with one or more parties. As populations have grown, so have the potential pools of parties looking to minimize risks by sharing the risks with others. Instead of placing all of their goods on a single ship, early merchants would place smaller amounts of goods on multiple ships (alongside other merchants), in the event one of the ships were to sink. Insurance typically involves a concept called “risk transfer”, where the policyholder transfers the risk of financial loss to the insurance company, in exchange for a fee (called premium), alongside many other policyholders seeking similar risk protection. Technically, they are not transferring the risk of the specific loss to the insurance company, because the insurance company does not literally go through the loss, but instead they are merely entering a contract to be reimbursed or compensated following a covered event.

Retain the risk – this involves accepting the loss from a risk, and is what is commonly known as self-insurance. Basically, any risk that cannot be avoided, and is not shared or transferred, is retained. Often, there is a combination of risk transfer and risk retention when it comes to insurance. The deductible, co-payment, and any loss in excess of what the policy pays, is retained. Why would someone retain the risk? Maybe the potential loss is so small that the cost to transfer that risk is high compared to the cost of paying for the loss itself. Or maybe the potential loss is so large, that it is either uninsurable, or the cost of insuring it is just not feasible.

So let’s delve a bit deeper into the guiding principles of insurance. The 4 principles are:

Insurable interest – this simply means that the person taking out the insurance would suffer a monetary loss upon the occurrence of the insured event. This is essential. Otherwise, one could insure property they have no interest in, and does not benefit by the safety of the property, and they could cause harm just to receive the policy’s financial benefit. 

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Utmost good faith – the insurance contract, like other contracts, must be based in good faith, and

would not be valid if the parties obtained the policy by way of fraud or misrepresentation. This is why you must answer policy application questions truthfully and accurately, and be sure to read the entire application prior to signing it, especially if someone other than yourself answers any of the questions. Why? If you misrepresent an answer on an insurance policy question, the insurance company can not only decline to pay your claim, even if the claim is completely unrelated to the application question, and even if the claim was otherwise covered by the terms of the policy, by rescinding the policy altogether. I call this “denial by rescission” and find some companies specifically and actively use this as a strategy to reduce claim payments (a little bit of risk reduction of their own).

Material facts disclosure – similar to utmost good faith, the person taking out the insurance has a duty to disclose material facts relevant to the subject property. This duty may even extend to material facts you are supposed to know about. Obvious examples would including disclosing your correct age and health condition on a life insurance policy, or the distance to a fire hydrant on a policy that insures against the risk of fire.

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Principle of indemnity – this principle states the insurance policy should be a contract of indemnity, and nothing more, so the person receiving the policy benefits after an insured loss would be no better off, nor worse off, than they would be had the loss never occurred. The idea here is that the person taking out the insurance should not be able to use the policy for “speculation”, or to profit from a loss.

In my experience, it is this last principle that insurance companies have deviated the most from in the past several decades, and they have done this to themselves in order to market their products more effectively as competition has increased. Replacement Cost coverage is one example, where the insurance company promises to pay you for a brand new item to replace your old item. Or maybe you have seen commercials recently for car insurance that promises to replace your old car with one that is a model year newer. These may be great concepts for marketing and sales, but they just don’t conform to the principle of indemnity.

Congratulations on completing your summer reading for today. I sure hope it was more interesting than the textbooks I had to read in college, and that you learned a bit in the process. Class dismissed!

Mark Goldwich is president of Gold Star Adjusters, a group of public insurance adjusters dedicated to helping citizens get the maximum settlement for any insurance claim.