How Insurance Works

Individuals, families, business, and other organization face innumerable possibilities of financial loss. These possibilities produce uncertainty in the management of their affairs. Therefore persons responsible for individual or group welfare - for instance, the head of a family or an executive in a corporation - purchase insurance to reduce or eliminate uncertainties.

Insurance is a social device that makes it possible for an individual or an organization to substitute a small definite cost for a large but uncertain loss, up to the amount of the insurance. Under this arrangement, the fortunate many who escape loss will help to compensate the unfortunate few who suffer loss.

Insurers keep the arrangement operating by mathematically anticipating the probable extent of losses and by accumulating premiums in order to pay the losses as they occur. Actuaries expert in the mathematics of insurance use mortality tables in the case of life insurance and other data on risk to forecast losses. The terms of the agreement between the insured and the insurer are expressed in a contract, the insurance policy. Based on the type of loss events covered, insurance policies fall into three classifications: personal, including death and disability; property, usually possessions of the insured; and liability, involving the person or property of the others.

Personal risks involve loss events that touch the person, such as financial loss arising out of premature death or disability. Generally, the lives involved include one's own immediate family or key business associates, persons in whom the assured has an insurable interest.

Property risks involve loss events that touch directly the property covered. Losses include the expense of repair or replacement and lost income derived from property use. The property that is the subject of insurance is usually owned by the insured. Liability risks involve loss events that concern the person or property of others, and for which an insured is legally responsible either through the contract or tort law.

Known to merchants and traders since the ancient world, insurance now flourishes in most part of the world. Privately owned insurance firms constitute major industries in the United States, Canada, Britain, and in some other advanced Western nations. Many governments operate social insurance programs.