The Concepts Of Insurance

Most everybody has heard all about the latest debates on health insurance. People from all parties and affiliations have put their own spin on the issue in order to win people’s opinions and trust. While important, that particular issue is beyond the range of this article. In this particular piece, I’ll go over the basic concepts of insurance, how it works and how it doesn’t work. Later on, when you hear people talking about it in the news, you can have a better understanding.

The concept of insurance is as old as the hills. What is likely the most famous company that has been around for hundreds of years is Lloyds of London. Back when the British Empire was sending out ships in search of new trading partners, they would insure them through Lloyds. If the ships came back with new riches, Lloyds would get a cut of the profits. If they disappeared, Lloyds would cover the loss.

Insurance today is based on the same principle. A protection against a potential loss. The mathematics is based on something called the Law of Large Numbers. The fundamental way that it works is if thousands of people contribute to a fund, that money is to be used to pay in case one of the individual contributors suffers an accident. This only works if the chances of an accident are much less than the sum total of the contributions.

In order to create a new policy, the insurance company has to evaluate the potential risks involved. If the risks are low enough, and they think they can afford to pay out in case of an accident or event, then they will initiate coverage. If, on the other hand, the risk is deemed to be too great, like car insurance for somebody who has been in twenty accidents, they will not be able to offer coverage.

The possibility of events happening has to be lower than the total amount of contributions by policyholders. If the risks start to be higher than the contributions, then the insurance company will have to pay out more than it takes in, and will go out of business. In order to protect against going out of business, the company will do one of two things.

First off is to start charging everybody more for their insurance. The second thing is to simply deny coverage for certain events, or to certain individuals who are higher risk than others.

The bottom line is that the less likely something is going to happen, the less you’ll have to pay to insure against it. The higher the chance become, the more you’ll have to pay.

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