The Insurance Principle

All insurance companies, including Texas health insurance companies, operate on a series of principles collectively known as the insurance principle. This set of concepts is what allows insurance companies to be extremely profitable corporations even while providing a financial safety net for individuals at risk of health problems, injuries, or property loss. Without a sound strategy based on the insurance principle, insurance companies as we know them would not exist.

Tenets of the Insurance Principle An insurer’s profit can be expressed as its income from premium payments and investments, less any payouts it has to make to customers. Improving this ratio is the focus of insurance principle application. Though interpretations and specific formulations may vary, the insurance principle can generally be broken down into three main points or tenets:

Statistical Risk Assessment
As an organization which essentially bets on the well-being of its customers, health insurance companies must be able to assess the statistical chance that a particular policyholder will be affected by a particular condition, injury, or illness. Based on medical data, US Census numbers, and other information-gathering sources, insurers can calculate statistical risk with surprising accuracy.

Calculating Reasonable Premiums
After risk assessment is complete, the company must then use a formula to calculate a reasonable premium for customers to pay. This premium must be designed to ensure company profitability (i.e., high enough to offset the risk of large payouts) but also to appeal to potential customers (i.e., low enough to be affordable and competitive in the market).

Large Consumer Base
Anyone who has ever flipped a coin knows that, statistically speaking, there is a 50-50 chance of it coming down either heads or tails. However, if you only flip a coin four times, it is perfectly possible for you to get a disproportionate result, such as three heads and one tails. Such a mistake could cost health insurance companies millions – how do they avoid it? The answer lies in a large consumer base. Though an individual consumer may defy statistical predictions, given a large enough number of policyholders, the aggregate result will conform very well to statistical predictions.

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