The Life Insurance Risk Pool- Part I
How is risk associated with life insurance? The answer to this question begins with the definition of risk. Simply stated from a life insurance perspective, risk is the possibility of financial loss. Generally speaking, there are two types of risk, pure risk and speculative risk.
Speculative risk is the possibility of a loss or gain. For example, gambling is a speculative risk because you may lose or you may win. The need for life insurance primarily deals with pure risk which is the possibility of loss only. It seeks to “indemnify”, that is, to make whole or restore something to its original value. For matters of discussion, we will focus on pure risk.
Under pure risk, there are two instances where a financial loss could occur: 1) as a reduction in the value of something that someone already possesses, or 2) as a reduction in the value of something that the individual does not currently have but anticipates to receive in the future. Now, how does this relate to life insurance?
Let’s now define insurance. Insurance is a risk-financing technique that transfers the financial burden of a risk from an “insured” to an “insurer” for a premium (price). Therefore, life insurance seeks to transfer the risk of a financial loss due to death on something someone already owns, like a home for example, or on something the person anticipates to receive, such as a paycheck for the next 20 years, to an insurance company.
All true insurances must have the elements of both risk transfer and the risk pooling. Risk transfer deals with how the insured’s view insurance, while risk pooling is from the viewpoint of how the insurer views it. The individual insured sees insurance as a means to eliminate, or at least reduce, the severity of the pure risk he or she faces by transferring it to the insurance company for a premium that is very small in comparison to what is being insured. The insurance company sees insurance as a way to accept similar infrequent risks from a large number of people, and by pooling them together into one large group, is able to reduce the overall risk it faces. Pooling the premiums of thousands of people and spreading the risk equitably across the entire pool allows the insurance company to also eliminate or reduce a loss.
Are you curious yet as to what concept is used by insurance companies to successfully implement risk pooling? Delve into Part II and I will further explain this for you. As I’m sure you can see by now, life insurance is an exceptional “technique” to help reduce your risk of loss. What a great and “equitable” invention!
About the author: Kyle McDonald holds FIC, FICF, FSCP® & CLTC designations. His viewpoint on life insurance is simple, “Anyone with a family must have life insurance. In the end, life insurance is for others you care about, not you.” He is ready to help you and your family get the best option available. Contact Kyle today at 1-800-651-1953 or KMcDonald@Pivot.com.