How Does Insurance Work?


Why did my insurance premiums increase?

I’ve had no accidents and why do my rates skyrocket after one accident? It’s the only claim I’ve ever filed!

Why do I pay more for insurance than my friend who lives only 10 miles away from me and has the same amount of cars and the same amount of drivers?

These are all valid questions and these are questions we get all the time.

Most of these questions can be answered by simply understanding how insurance works. Now, that doesn’t mean you have to like it; but at least you’ll know why these things are happening.

We are going to touch on three important things:

  • Insurance companies use data
  • They have to file rates with the government
  • Insurance is a pool
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Insurance Companies Use Data

The first point we’re going to talk about is that insurance companies use data. Now this is something that’s probably pretty odd to discuss, but it’s something that’s very important to point out and explain how they use the data.

Insurance companies are not simply guessing and often changing what rate they’re going to give you, that’s not how it works. You can’t simply call into an insurance company and negotiate rates. That’s not how it works.

Most, every single insurance company in the world uses hundreds of points of data and they take all of those points of data, put them together, and that’s how they come up with your insurance premium.

Data points like your age, your location, the age of your home, how many people live in your home, how many drivers are listed on your auto insurance policy, where you live, down to the very street where you live, and the list goes on and on and on. Again, it’s not four or five points of data. They are looking at hundreds of points of data to determine your insurance rate.

This is why even though it seems and appears that you have the same policy as your friend, who lives 10 miles down the road, you don’t. This is why you have different rates.

So that’s the first point to understand: insurance companies use data.

They are not simply guessing each time you come to them for an insurance rate. They are using the data and the data tells them what insurance premium to charge you.

Insurance Companies File Rates With The Government

The second point we’re going to talk about is insurance companies have to file their rates and policies with the state department of insurance or the DOI. This, again, is why you cannot simply call up an insurance company and negotiate rates. The insurance company has to set these things with the state and then they have to stick to those rates and policies that they told the state’s department of insurance that they would.

Each insurance company has to file three things with the state’s department of insurance.

  • Rate Filing
  • Form Filing
  • Rule Filing

The first thing they have to file is the rate filing.

This is the rates and the calculations that they use to determine your insurance premium or in other words, how much you’re going to pay based off of all those data points for your insurance policy. They are bound by this and they cannot change that rate filing willy-nilly.

They can only change it when they submit it to the state and then get approval back. It’s not something that they can change from day to day or from customer to customer.

The second thing that the insurance company has to file with the department of insurance is the form filing.

This is the actual policy that they issue where they go through everything that’s covered and everything that is excluded.

Again, this is something that has to be approved by the department of insurance and then once it’s approved, the insurance company cannot change it until they submit an additional filing and get approval for that.

Rule Filing

And the third thing that all insurance companies have to file with the department of insurance is the rule filing. This is the list of guidelines that the insurance company uses to determine who is eligible for each policy within that insurance company. Now, these three things we briefly touched on them on a high level, but we touch on them so that you can understand that insurance companies are bound and regulated by the department of insurance.

They cannot simply change these policies and these rates and these rules from customer to customer. They have to be uniform for every single person.

Insurance Is A Pool

And the third and final point that we’re going to touch on when it comes to understanding how insurance works is: insurance is a pool.

So now that we know about the first two points that they use data and they have to file all that stuff with the department of insurance.

Let’s talk about insurance being a pool and what that means. The insurance company will take all of that data that they get and that they have for each individual client. And then they will take that data and put you into a pool with thousands, if not hundreds of thousands of other people that are also paying for an insurance policy with that specific company. The insurance company charges a premium for everybody inside of that pool. Again, everybody’s premium is different based off of those data points.

They then have all of this premium in one single pool. Then, when somebody in that pool has an accident or has a claim, the insurance company takes the money from that pool to pay out that person and make them whole again.

It’s not very likely that everybody in that pool will have a claim at the same time and that’s how insurance works. So there may be times where you are paying your premium for years and years and you’re never using the insurance. However, there are other people in your pool who are pulling from your premiums when they have claims that they need to file. Doesn’t seem fair until you’re the one with the huge loss with a $500,000 home that burns to the ground and then you get to use money in that pool to rebuild your home and make you whole again.

So again, it’s everybody pulling resources through the premium that the insurance company collects. Then when people in that pool need to use it, the money is there to restore and repair whatever went wrong.

This is why many times your insurance premium goes up when your policy renews and you’ve had no accidents, you had no claims.

So those are the three things that we’ve talked about that help you understand how insurance works.

  • Number one: insurance companies use data
  • Number two: insurance companies have to file their rates and policies with the DOI
  • number three: insurance is a pool

Now you know and understand how insurance works!

No more wondering:

  • How Does Car Insurance Work
  • How Does Life Insurance Work
  • How does any type of insurance work…

Because now you know!

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