Most of us define insurance by what it does for us under the policies we have purchased. If asked “what is insurance?,” most people would say “it pays for damage to my car” or “it pays my medical bills if I get sick” or something to that effect. These are good working definitions, but a closer look at what the nature of the insurance policy really is can be instructive. One relatively simple definition states:
Insurance is a contract, represented by a policy, in which an individual or entity receives financial protection or reimbursement against losses from an insurance company. The company pools clients’ risks to make payments more affordable for the insured. Insurance policies are used to hedge against the risk of financial losses, both big and small, that may result from damage to the insured or her property, or from liability for damage or injury caused to a third party.
It’s easy to see from this definition that an insurance company’s business model involves it taking (and managing) risks. It agrees to pay losses under the contract in return for a premium from the insured, with the hopes that it will take in more premium dollars from its pool of policyholders than it will have to pay out on clams. Another key aspect of an insurance company’s business model is to make money investing the premium money it takes in before it has to pay that money out on claims. This will be the subject of a later post.
The insurance company is not guaranteed (nor does it have a right) to make a profit in its business. If the company is smart and takes good risks, it can most definitely make a profit. Many companies make huge profits (it’s easy to see this is true by checking their stock prices or imagining how much money they spend on all those TV ads). But, if the company takes bad risks or is unfortunate enough to suffer big losses from a natural catastrophe (like the hurricanes we’ve seen so often recently), it might not make a profit in a given year.
Whether the insurance company makes a profit in a given year or not is not the policyholder’s problem. The policyholder has bought with her premium money the promises of coverage the insurance company is selling. Those promises include peace of mind, security and protection from financial harm if the policyholder is unfortunate to suffer a loss. The insurance company has promised in the insurance contract (the policy) to pay covered claims, and they must live up to that promise regardless of whether doing so will adversely affect the company’s profitability.
One of the fundamentals of good faith claim handling is that an insurance company must never place its own financial interests ahead of its insured’s financial interests. When an insurance company attempts to use its claims department as a profit center (by delaying, denying or underpaying valid claims to try to improve the company’s profitability), it is in bad faith.
Unfortunately, all too often insurance adjusters, supervisors, managers and claim department executives lose sight of this bedrock principle. When they do, and the policyholder suffers as a result, a bad faith lawsuit it likely to follow.