What is the primary purpose of an insurance premium?

The primary purpose of an insurance premium is to fund potential claims made by policyholders. When individuals or businesses purchase insurance, they do so to protect themselves against certain risks by paying a premium. This premium is not just a fee; it is a financial contribution that allows the insurer to pool resources together. The idea is that while only a small number of policyholders will actually file claims during a given period, the premiums collected from all policyholders can cover these claims when they arise.

By collecting premiums, the insurance company ensures that it has the financial ability to pay out claims to those who have experienced losses, thus fulfilling its promise to policyholders. This risk pooling concept is fundamental to how insurance operates, as it creates a safety net for those policyholders who do face insured events.

While operational costs, agent salaries, and other expenses are factors in running an insurance business, they are secondary to the central role that premiums play in ensuring claim payouts. This understanding of the premium's purpose is critical for those studying insurance laws and rules in Massachusetts.