So we’ve all heard about the huge health insurance debate that has raged in this country for many years now. Parties on either side of the aisle have presented their case in hopes to sway the voters over to their point of view. While these are important issues, it is way beyond the scope of this article. In this article, I’ll go over the very basics of insurance, it’s principles and terminology. That way, when you hear news reports and such, you’ll be better informed.
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.
Today, insurance is based on the same principle. It is a protection against potential losses due to unforeseen events. The math is based on an idea called the “Law of Large Numbers.” This means that when there are thousands of people paying a little bit of money each, if one of them has a terrible accident, the insurance company will be able to pay out enough to cover their costs, while still being able to stay in business.
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.
To stay in business, the insurance company has to make sure that any risk of any event happening is smaller than the total amount of people participating in the plan. If the risks start to get too large, then the company will have to do one of two things.
