Insurance Companies and the Role They Play in Corporate Finance
Insurance companies are a special type of financial institution that deals in the business of managing risk. A corporation periodically gives them money and, in return, they promise to pay for the losses the corporation incurs if some unfortunate event occurs, causing damage to the well-being of the organization.
Here are a few terms you need to know when considering insurance companies:
Deductible: The amount that the insured must pay before the insurer will pay anything
Premium: The periodic payments the insured makes to ensure coverage
Co-pay: An expense that the insured pays when sharing the cost with the insurer
Indemnify: A promise to compensate one for losses experienced
Claim: The act of reporting an insurable incident to request that the insurer pay for coverage
Benefits: The money the insured receives from the insurance company when something goes wrong
You’re probably thinking to yourself right now, “Wait. You pay the insurance company to indemnify your assets, but then it makes you pay a premium, deductible, and co-pay and caps your benefits? What’s the point?”
Insurance companies can calculate the probability of something happening and then charge you a price based on the estimated cost of insuring you. They generate profits by charging more than your statistical cost of making claims.
Think of it like this: As a nation, people in the U.S. overpay for everything that’s insured by an amount equal to the profits of the insurance companies. Originally, this setup allowed corporations and individuals to share the risk of loss; each person paid just a little bit so no person had to face the full cost of a serious disaster.
Unfortunately, this is decreasingly the case, as insurance companies grow in profitability and incur unnecessary overhead costs. That’s precisely why many nations require their insurance companies to operate as nonprofit organizations.
You can insure just about anything on the planet. (Consider that Lloyd’s of London will insure the hands of a concert pianist or the tongue of a famous wine taster!)
Health insurance companies
Corporations deal a lot with health insurance companies because their employees often demand health insurance — not to mention healthy employees tend to be more productive. Health insurance is a very popular benefit for employees because being insured as a part of a large group is generally less expensive than trying to find individual insurance:
Group insurance is cheaper than individual insurance because the probability of large groups of people being rewarded more than they pay in premiums is lower than that of individuals.
Group insurance was frequently the only option that allowed for coverage on preexisting conditions (conditions people developed before receiving insurance); however, under the Patient Protection and Affordable Care Act, insurance companies can no longer deny coverage to people.
Health maintenance organizations (HMOs) are a popular, and often cheaper, insurance option for both corporation and individuals because they require everyone insured to go through a general physician, who acts as a kind of gatekeeper by determining whether a referral to a specialist is required.
Life insurance companies
Life insurance companies work similarly to other types of insurance companies, except that the only time they pay benefits is when you die. Corporations sometimes take life insurance policies on critical employees who have specialized skills or knowledge that can’t be easily replaced without significant financial losses.
Many corporations also offer group life insurance which, like health insurance, is cheaper than individual insurance. Life insurance comes in two basic flavors: whole and term.
Each one has a wealth of variations and additional options. The types have many differences, but the primary distinction is that term life insurance is paid for a set period and is only valid as long as it is being paid, while whole life insurance is considered permanent and will build value over time.
Property-casualty insurance companies
Property-casualty insurance is the most critical type of insurance for corporations to have. It covers the potential harm that can befall a company or anyone on property owned by the company should an accident occur. Did a meteor fall from the sky and smash your headquarters? That’s insurable!