Insurance 101:
An Introduction to the Basics

Before September 11, 2001, the insurance industry was already experiencing significant changes and insurance companies were already losing money. Any chance for gradual change has vanished as the insurance industry faces the most significant loss in its history. MCCCD's insurance premiums increased 57% on November 1, 2001, and increases are anticipated to be much higher on our next insurance renewal on November 1, 2002. The following article is the first in a series to assist you in understanding commercial business insurance.

Risk transfer has always been, and will continue to be an essential tool for managing risk. It allows an individual to transfer the risk of loss to a commercial insurer, who then spreads it among many individuals for a fixed premium. Admittedly, the insurance market is subject to cycles that can have a serious impact on higher education institutions as demonstrated by the current insurance market. Although the function of risk managers has evolved into something more than simply being an insurance buyer, it should be noted that the concept of insurance and the concept of spreading risk will almost always make economic sense.

With the exception of risk management and/or insurance professionals, insurance in any form is often thought of as a "necessary evil"; something somebody said you needed to pay for the damage to your home when and if a fire destroyed a part or all of it, and what you were told you had to have when you bought your first car. The purchase or involvement of insurance for most of us has usually been something between you and your insurance agent, the bank, the mortgage company, and the person with whom you had a fender-bender. To most people, insurance benefits are the fine print on the back of the policy that you can neither read nor understand, and you usually don't need to know anything about unless there is a problem when you file a claim with your insurance company.

One of the key components of a risk management program is risk financing. Risk financing is the management (planning, organizing, directing, and controlling) of the sources and uses of funds with which an organization finances its recovery from accidental property, liability, and criminal losses. Risk financing involves planning and arranging for the sources of these funds before any such losses occur and directing and controlling the funds when losses occur.

Commercial insurance may well be the most widely used risk financing technique and the major source of funds to finance recovery from accidental losses for most private and public organizations in the world. For a very large percentage of small organizations, purchasing insurance from an insurance company is the only way to arrange for funds to pay for losses, especially those that are large relative to the organization's own financial resources. Thus, insurance is the first (and sometimes only) risk financing technique for many organizations; other techniques may be used but they are normally exceptions to the purchase of insurance.

Because of our size, MCCCD utilizes a hybrid risk financing approach. We utilize a self-insured retention, and we purchase insurance. Under a self-insured retention (SIR) program, we assume the first layer of a loss up to a predetermined level (e.g., $100,000 for liability losses). We act like our own insurance company; we are responsible for claims handling, defense, and reserves within this retained layer. Excess insurance is purchased for those claims which exceed our SIR.

In the context of risk management, insurance is not only one of many risk financing techniques, but also a legal contract. Thus, a reasonable definition of insurance is:

"An agreement by which one party, for a consideration usually known as a premium, promises to pay money or its equivalent, or to do an act valuable to the insured, upon the destruction, loss, or injury of something or someone in which the insured party held an interest."

--Tiller, Blinn, Kelly,
Essentials of Risk Financing,
Insurance Institute of America
1988.

The MCCCD risk manager negotiates the purchase of the following comprehensive insurance coverages: Property and Boiler/Machinery; Liability, and Crime. These coverages will be discussed in detail in the next installment of Insurance 101.

Published in the Spring 2002 Edition of In Brief