Does insurance confuse you? Find out how to make sense of insurance and make an informed decision on your next purchase.

1. The Complete Health Spending Account eBook Series
Three Keys
to
Understanding
Insurance
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VIDEO OVERVIEW
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3. The purpose of this guide is to help you understand insurance. We’ll
accomplish this task in three sections:
1.
2.
3.
First, we will give you a clear definition of insurance.
Next, we will show you the difference between an insurance
event (also known as a pooled event) and an administrative
event (also known as an experience event). In other words, we
want to show you what insurance is and what insurance is not.
Following on this point, we will show you what you should
always insure and should never insure.
OK …let’s dive into
Three Keys
to Understanding Insurance!

4. What is insurance?
Let’s take a look at a formal definition. Investopedia defines insurance
as “a contract (policy) in which an individual or entity receives financial
protection or reimbursement against losses from an insurance company.
The company pools client risks to make payments more affordable for
the insured.”
In essence, insurance is the transfer of risk from one entity (you) to
another (the insurance company) in exchange for a payment. Therefore,
insurance is about risk sharing. Specifically, the risk is (usually) an
unexpected financial loss.
For example, there is a risk that your home may be damaged from
a natural disaster. You transfer the risk to the insurer (along with
thousands of other home owners), and in return for the insurance
company absorbing that risk, you are charged a premium (a form of
payment).
Now that we have a working definition of insurance, we will show you
the difference between an insurance event and administrative event.
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5. What is the difference between an insurance
(pooled) and an administrative (experience) event?
An insurance or pooled event has three primary characteristics:
1. Uncertainty - you don’t know where or if there will be a claim
2. Low incidence of claim – claims occur rarely
3. Expensive claim amount
Example: Home Insurance
You, as well as your neighbors and friends, insure your respective homes. You transfer
the risk of damage to your home to the insurance company. In exchange for the
transfer of risk, you pay a premium to the insurance company. All of the premiums
are put into a pool. As there are more people contributing to the pool than there are
making a claim, the insurance company is able to pay claims.
An administrative or experienced event has three primary characteristics:
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1. Certainty – you expect there will be a claim
2. High incidence of claim – claims occur regularly
3. Less expensive claim amount

6. Example: Maintenance and Planned Medical Events
We all visit the dentist for annual or semi-annual checkups. Perhaps we occasionally
see a chiropractor, physiotherapist, or other service professionals. All of these
routine, maintenance, and planned events are experienced (administrative) events.
This means your premiums are established by the usage of your benefits.
Why would you insure an event that you expect to happen? There is not
much risk with an administrative event yet you are paying a significant
mark up (in the form of a premium) to the insurance company.
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7. What should you always insure and what should you
never insure?
Dental services are a great example of administrative events. Dental services
are almost exclusively planned events. You will have a dental checkup. You
will have an x-ray. You will have scaling and polishing. You may have to
have that root canal if you have an abscessed tooth. All of these events fall
into the category of maintenance events. Coincidentally, dental premiums
represent upwards of 70% of a health and dental insurance plan.
Conversely, let’s say your son dove into the pool at the local recreation
centre and broke his front adult tooth on the bottom of the pool. This was
an unplanned emergency dental event. This event can be insured under
an accidental dental insurance policy. This falls into the pooled insurance
event category (no pun intended on the “pool” word).
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The point here is that you should question the validity of insuring an event
that you expect to happen. Visits to the dentist, a paramedical practitioner,
and other events based on your “experience” (or usage) are questionable
events to insure. You are essentially paying the insurance company a
premium to perform administrative duties on your planned events.

8. If we take a historical look at insurance premiums versus payout in claims, an
insurance company is essentially marking up the cost of your planned event
by 32-40%. An insurer’s objective is to maintain claim costs equal to a fixed
percentage of a premium. This is essentially the break even position for the
insurer and is referred to as a target less ratio. The remaining percentage is
reserved for “adjustment” expenses. Adjustment expenses include the cost
to collect premium, cost to process & monitor claims, agent commission,
taxes, inflation, plan design, overhead, and profit.
Example:
Let’s say the premium is $100 and the target loss ratio is $70. The remaining $30
is the amount the insurer needs to stay profitable. If you spend more than $70
you will get an increase in your premium the following year. If you claim less, the
chance of getting a reduced premium will depend on how the insurer feels about
the adjustment expenses. In short, if you spend $70 on medically related events out
of a premium of $100, this represents a 42.2% markup.
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9. Conclusion
and
Additional
Resources

10. Insurance is about risk sharing. Insurance involves the transfer of risk from one
entity to another in exchange for a payment. Specifically, the risk is usually an
unexpected financial loss.
Today, there is widespread confusion on what constitutes an insurance event
and an administrative event. An insurance event is characterized by a high
degree of uncertainty, a low frequency of claims, and expensive claim payouts.
On the other hand, an administrative event is typified by the exact opposite: a
high degree of certainty, high frequency of claims, and less costly payouts.
When you purchase health and dental insurance for administrative
events, you are essentially paying a significant markup to the
insurance company to perform these events. You will improve
your financial position by paying for your administrative
events (health and dental expenses) out of pocket or
if you own a corporation, by using a Health Spending
Account. Go ahead and insure your home, but think twice
before you purchase insurance for your health and dental
procedures.

11. Discover
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Health Spending
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Now that you’re familiar with Health
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