Introduction to Insurance

Introduction to Insurance

 Insurance is the voluntary exchange from one party to another of the risk of some financial loss.

I don't know what you mean by how does the concept exist. When leople face a low-risk, large expense, they can work together so that the insured person faces a known risk with a much lower expense.

Suppose there are 100 homeowners. Each house is worth $100,000. There is a 1% chance that each house will burn down this year.

So, if any homeowner's house burns down, he will have to pay $100,000. Otherwise, he pays nothing, 99% of the time.

For 20 years nothing could happen, and a homeowner pays nothing toward home rebuilding. But then, , his home burns down and he gets hit with an actual large bill for $100,000. Most people couldn't afford to rebuild their home if they had to.

But, on average, the homeowner could pay $1,000 every year to rebuild. He could save it in an account. But it would still take a long time to get that rebuilding find up to $100,000. If his home burned down after 20 years, he would only have a little more than $20,000 saved up. Leaving him with an expense of $80,000. Most people couldn't afford that either.

But a whole lot of other homeowners are in the same situation with similar risks.

So the homeowners can pool their risk together. Every year, each person actually pays $1,000 into an insurance pool. And if any home burns down, the pool will pay that amount to the homeowner.

The numbers don't work out so , (because there is a risk that several houses could burn down every year). And the plan administrator has ongoing operational costs.

But that is a very general idea. Insurance converts a high, uncertain cost into a lower, certain cost. The homeowner makes a regular payment to the insurer, and insurer agrees to pay the whole loss if it happens.

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