What is insurance and why would I want it?

“The essence of insurance is to transfer risk away from yourself.”

Insurance combines two basic concepts together, transfer of risk and spreading risk out. An insurance policy is nothing more than a contract or an agreement made between an individual and an insurance company. The insurance company agrees to take the risk of a large loss on your home or auto for example, and trades that risk for a premium that you pay in hard earned dollars. The insurance company then combines that risk with other risks of like kind and thus spreads the risk across a larger population. This works because the likelihood of multiple people having a loss at the same time is minimal. When a loss occurs the company has a pool of money made up of all the premium dollars that people have paid. When a person has a need, or a claim, the insurance company gives that person money from the pool in proportion to that need. At the end of the year the insurance company hopes to have money left over in the pool that they can call profit. The amount of money in the pool at the end of the year doesn’t always fall to the favor of the insurance company.