Insurance Game

Almost everyone maintains various types of insurance.  These include health insurance, automobile insurance, property insurance, life insurance, and numerous other types of insurance.  One form of insurance that is of particular importance for members of the real estate industry is errors and omissions insurance.  This form of insurance is intended to provide protection in the event a consumer files a claim against a member of the real estate industry in connection with the services rendered by that member.

So what is insurance and why does it make sense to have it?  Insurance, in essence, is the pooling of resources among a group of people so that they can share the risk of a problem, should it occur.  By way of example, let us say there is a group of one thousand people and there is a risk of one of those people being faced with a liability of one million dollars.  For any one person, the reality of being forced to pay one million dollars could have a catastrophic impact.  On the other hand, if each of those people agreed to pay $1,200 to avoid the risk that they might have to pay a million dollars in the event of liability for a claim -- while that would be a significant price and would entail a payment somewhat greater than the likelihood that they would be the one in one thousand to face such liability -- it would protect them from the catastrophic risk of a million dollar claim.

In fact, that is how insurance generally works.  An entity, generally an insurance company, evaluates the likelihood of liability for a group of people.  The insurance company then pools the resources of the various members of that group into a fund.  The amount of money needed for that pool needs to be sufficient to cover potential liabilities for the group, along with some additional sum to provide the insurance company with a return for their efforts and for the risk they take by agreeing to pay, up to some defined amount, any liabilities the group incurs.

The amount of money paid for insurance by the various members is called the insurance premium.  This is how the pool is funded.  The greater the risk of liability, the more money that is needed to fund the pool.

Most insurance policies define the maximum amount of money which the insurance company will be obligated to pay on a particular claim and on behalf of a particular member of the group for all claims within a given policy period.  This is known as the “policy limits.”  The “policy limits” serves to protect the various members of the pool from having the entire pool of funds disproportionately exhausted by one member.

Many policies provide that the individual member has to pay the first portion of any claim, which is called the “deductible.”  The “deductible” is often limited to the first money paid to defend the claim, otherwise known as a “defense deductible.”  Sometimes, the “deductible” is limited to the first funds paid to the claimant, otherwise known as the “indemnity deductible.”  Other times, the “deductible” can apply to money paid for either the defense of the claim or the payment of indemnity to the claimant, otherwise known as a “combined deductible.”

Most insurance policies also define the types of claims for which the pool of funds can be used.  These are commonly referred to as issues of “coverage.”  Each policy sets forth in great detail the types of matters which will be covered by the carrier.  Once again, the scope of coverage for the pool will dictate the amount of money needed to fund the pool.  The more expansive the coverage, the more money needed to fund the pool and the greater the contribution required from each individual member.
Page 2:  The Insurance Game

Parenthetically, there are some areas which by law cannot be covered by an insurance carrier.  One example of this is coverage for intentional acts such as fraud because it is against public policy to permit people to buy insurance which protects them against the consequence of intentionally wrongful acts.

With the foregoing in mind, it is important for the members of the group of insureds to recognize the risk/benefit factors which apply to the entire group.  On an individual basis, a particular member who is the target of a claim may prefer broad coverage, with low deductibles, and may also wish to fight every claim regardless of the actual cost.  This, however, has an adverse impact on the group as a whole, because the associated costs will require that individual members of the group pay more in premiums to fund the pool.  The critical point to remember is that the more money paid by the insurer, whether to defend claims or to pay indemnity on claims, the more money which individual members will be required to pay to keep the pool sufficiently filled to pay for future claims.

For these reasons, when faced with issues involving insurance, it is important to balance one’s immediate needs and desires as a potential target of a claim with the impact on the pool as a whole.  In the final analysis, the preservation of the group must take precedence over the needs and desires of the individual.  Otherwise, the ability to create an efficient and cost-effective pool of insurance will cease to exist and each member will be faced with the prospect of bearing the individual risk of a catastrophic claim.

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