Final answer:
The AD&D rider attached to a life insurance policy pays the principal sum upon the accidental death of the policyholder. Insurance companies collect premiums to cover claims and operational costs, ensuring financial support for such unexpected events.
Step-by-step explanation:
The principal sum of an Accidental Death & Dismemberment (AD&D) rider attached to a life insurance policy pays out when the policyholder dies due to an accident. This is a supplemental policy that enhances the basic life insurance coverage. In the event of a qualifying accident, the AD&D rider provides additional financial protection to the beneficiaries on top of the standard life insurance benefit. For example, if a policyholder with a life insurance policy that includes an AD&D rider dies in a car crash, the death benefit from the main policy and the additional sum from the AD&D rider will both be paid to the beneficiaries.
Insurance companies collect premiums from policyholders to cover the costs of various claims, operational expenses, and generate profits. When a policyholder dies accidentally, the insurance company will use accumulated funds from premiums to pay out the claim. Policyholders contribute to insurance with the understanding that their premiums will be pooled with others to provide financial support during unexpected events. It is a fundamental law of the insurance industry that the collected premiums must be sufficient to meet all these financial obligations.
Furthermore, life insurance companies often have extensive cash reserves from paid premiums. These reserves are also used to provide loans or allow policyholders to borrow against their policies, which is an additional service beyond the claim payouts. The purpose of this is to offer financial flexibility to clients while ensuring the company's ability to cover potential claims.