In simple terms, insurance allows someone who suffers a loss or accident to be compensated for the effects of their misfortune. It lets you protect yourself against everyday risks to your health, home and financial situation.
Basically, insurance enables those who suffer a loss or accident to be compensated for the effects of their misfortune. The payments come from a fund of money contributed by all the holders of individual insurance policies. In other words, individual risks are pooled and shared, with each policyholder making a contribution to the common fund.
The contribution is known as the premium. Premiums are paid to insurers - these are institutions which accumulate the money into the fund from which claims are paid. The loss is in fact paid for by the policyholder making the claim and by all the other policyholders who have not suffered in the same way.
Insurers are professional risk takers. They know the probability of different types of risk happening. They can calculate the premiums needed to create a fund large enough to cover likely loss payments. Clearly, only a proportion of policyholders will require compensation from the fund at any one time.
So two important factors arise when calculating the premium. Firstly, the general likelihood that a loss will occur. Secondly, whether the particular policyholder is above or below average in risk.
Take three examples. In motor insurance a young person with a high powered car, or a driver with a long history of accidents will pay a higher premium than a mature and experienced driver with a modest saloon who has been accident free.
Similarly, the owner of a fish and chip shop will pay a higher premium for his fire insurance than, say, the owner of an office. The risk is greater, so the premium is higher.
Someone who is young, fit and in a risk-free job will find it easier to buy life insurance, and will pay lower premiums than someone who has a heart condition or is in a risky occupation.
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