How does insurance work? I may pay $33 a month for auto. But how the heck do they pay me $12000 if i wreck it?
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Answer:
I believe they take the premiums you pay them and invest them and make interest off them.
usually if you file a claim your premiums go up
They get 100,000 people to pay them $33 a month. Then hopefully only 100 wreck the car.. then to be sure that they make money. They only pay you $6000 because your car depreciated when you drove it off of the lot.
They bet you $33 a month that you won't wreck your car, and you bet them that you will. We all place our bets every month, but most of us don't wreck our cars, so they get to keep those bets. The ones who wreck their cars win their bets and buy new cars with their winnings..
Also, people invest in insurance companies, but the companies would rather pay them premiums than use their money to pay out claims. That is why some insurance companies go bankrupt after a very big occurrence, like a hurricane.
Like gambling, it's all about risk. They're banking, literally, on insuring lower risk persons over higher risks persons.
A portion of your premium goes into a "pool" of funds which are invested. Whenever someone has a loss, reserves are set aside and the claim is paid using these reserves.
Problem is, when you factor things such as insurance fraud, rising costs of repairs (materials, labor rates, etc.), natural disasters (like Katrina) the insurance companies are forced to raise their rates to compensate for these things. Howver, when companies properly control their expenses and only pay for damages that are legally owed by law as well as under the contract, and when the DOI allows for a rate reduction...the insurance companies will lower premiums across the board.
It's called "the law of large numbers". The larger the group is, the more accurately you can predict future losses. You divide the loss cost among the group members, so you collect enough from EVERYONE to pay the loss.
Not everyone who pays $33 a month for auto insurance will have an accident. Once you DO Have one, I promise, you won't be paying $33 a month for insurance any more!
As an example, for every 1,000 people that own a house, only one of those houses is going to have a fire, and only one in 50 fires will be a "total loss". So you take ALL those people, average the cost of the houses, divide out the premiums, that's why you don't have to pay $12,000 for your car insurance.
Insurance is gambling, and you can be pretty sure that the companies have a good handle on the odds. If the odds are against you, your rates will be higher than someone who's odds are in their favor.
Yes they can Kyle like others have said it's the Law of Large Numbers. Also insurance companies invest much of the money for return, making money off the money paid in premiums. Insurance companies need to have the reserves neccessary to handle catastrophic losses so when that big hurricane hits or that tornado tears up the midwest they are able to handle the financial hit. After that accident on your next renewal if you were at fault you'll have a nice surcharge because of it for three years.
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