Image: Unsplash
Image: Unsplash

Fundamentals of Finance: What is insurance?

Sometimes, things happen.  Things break, costing you money to repair or replace. Insurance is a measure taken to deal with this – to mitigate the financial impact of unexpected losses.  In return for a regular small payment, an insurer will promise to provide compensation in the event of a loss, proportional to the damages sustained.  This contract takes the form of a policy between two entities, the policyholder and the insurer.  The policyholder may be an individual or a corporation (not that the US Supreme Court could tell the difference) and pay a premium to the insurer.  The terms of insurance policies are strictly defined in terms of what constitutes a “loss”, on which clients can claim compensation.  The insurer’s job is to assume financial responsibility for damages on behalf of the policyholder, and perform analysis to determine the specific cost of damages accurately and calculate the probability (often through actuarial analysis) it may happen to determine the overall risk – and set the price of the insurance policy accordingly.

Insurance is a measure taken to deal with this – to mitigate the financial impact of unexpected losses

Insurance companies sustain their business model by taking on the risk of many clients – each instance of compensation may be costly, but they are rare overall.  The trouble is distributed widely, and the income from premiums covers the costs from providing balance.  They also perform due diligence on any claims made.  If the claim does not meet the contract’s strict requirements, insurers are not obliged to compensate a penny.  Furthermore, insurance companies can reinsure themselves – by taking insurance on the risk they have to pay a claim, the risk is even further distributed across different corporations.  Insurance brokers specialise in matching customers with insurers, marketing insurance services to the general public, and insurance underwriters focus on expertly understanding one field of risk and providing reinsurance to insurance companies in that area.

Many things can be insured, such as your holiday, business, or even Whitney Houston’s voice.  The most common types of insurance are health, home, motor, life, and professional insurance.  These forms of insurance are essential because most people risk loss in these areas.  Most governments widely mandate health, motor, contents and professional insurance: through national health insurance, they can ensure most people receive the healthcare they need; Motor insurance is required to drive on public roads, and many professions (like medicine or law) require liability insurance in the case that malpractice harms a client.  A house is the most valuable asset that many people own, and taking insurance against it can ensure that, even in the worst-case scenarios, a family will have somewhere to live.  Contents insurance is for individual possessions, for the risk that they are lost or stolen – a good idea if you lose your phone often.  Overall, insurance is a valuable part of our economy – providing a backup plan for when things go wrong.  It is up to you to decide what you want to ensure – to me, the most important things are always worth protecting, but I’m happy to trust minor stuff to my responsibility. 

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