Like Car Insurance

When you obtain an insurance policy, whether it is for your car or home, the company that provides you with that policy is concerned about what type of risk you will be. They want to make sure that you are not going to cause them to pay out a lot of money. Just like any business, insurance companies want to make a profit. To make sure you are a risk worth taking insurance companies evaluate the following 2 things.

1. Claim risk. Ideally, you never really have to use your insurance. Unfortunately, things happen and that's what insurance is for. Insurance companies on the other hand want to make sure those things are kept to a minimum. They do this by rating different policies based amount the amount of risk they pose. For example, to rate an auto insurance policy there are various factors that are taken into account. Some of those factors include age, gender, vehicle use, type of vehicle, coverage limits, address, driving record, driver's occupation, and even education level. Insurance companies do studies to determine the amount of risk they are incurring and then rate those risks accordingly. Insurance companies are more than willing to pay claims when it is necessary, but they want to make sure they stay solvent by charging a fair price.

2. Payment risk. Many are confused by why it is necessary to check credit for any type of insurance. An insurance policy is actually a unilateral contract. What does that mean? On investopedia.com it explains a unilateral contract as a "contract type where one party is legally obligated to uphold the terms of the contract." Read more: http://www.investopedia.com/terms/u/unilateral-contract.asp#ixzz1d2YaKNIe. An insurance policy is a unilateral contract because you are not legally obligated to uphold the terms of the contract, but the insurance company is legally obligated to pay claims as long as the policy is in force. Obviously the policy would not be in force if you did not pay, but you are not legally obligated to adhere to the entire length of the policy. (Keep in mind that there are some cancellation charges associated with some types of policies). Since you are not legally obligated to adhere to the policy, insurance companies want to make sure that you have a history of paying your bills and paying them on time. When someone does not pay a bill on time, it costs that company time and money to try to collect. Costs include the extra letters and postage, the time a worker spends calling or sending notices, and the time that money is not in the company's bank account is interest lost. This is one of the reasons insurance companies often check credit to rate the policy. There are some homeowner's insurance companies that do not check credit. I would assume that is because homeowner's insurance is usually paid through the mortgage company, which makes collection risks minimal.

There are many factors that go into rating insurance policies. Generally speaking these factors fall into two categories: claim risk and payment risk. Insurance companies want to make sure they stay solvent by rating different policies according to their risk. Life is risky, but insurance provides you peace of mind that certain risks are covered.