INSURANCE: HOW DOES IT WORK?
Insurance may be considered a game of risk in which individuals and businesses protect themselves, their families, and their property from possible losses resulting from unpredictable events such as storms, fires, accidents, and illnesses. The first rule of the game, devised centuries ago, is «share the risk». To play by this rule, many people take a small loss in place of one person’s taking a large one.
It is a simple idea: An individual pays a small amount of money called a premium to an agent who acts on behalf of an insurance company, or underwriter, which holds the individual’s premium and the premiums paid by thousands of others. The individual receives an insurance policy, a promise that if there is a loss to the individual as defined in the policy the insurance company will pay for it. The funds will come from the individual’s premium, the premiums paid by others who did not have losses, and money from the company’s investment of all the premiums. An individual who does not have a loss loses the premium money but purchases what insurance underwriters call «peace of mind». It is a gamble for both the customer and the underwriter, but it is built on the first rule of risk: those losses are small when shared by many.