How Can Insurance Spread Risk?


Insurance Basics

Just about everyone has some sort of insurance for something. From car and health insurance to business or flood insurance, there are many choices out there, and they all work basically the same way. You pay a premium each month to guarantee that if something happens, you will be financially covered. This means that, if needed, the insurance company will pay any bills or other costs associated with damage, health or harm done to others.


The premiums are the main reason insurance companies don't have to worry about the money they pay back to customers. They receive payments every month from all customers, but only have to pay out on a small percentage of claims. By doing this, they are making generating a profit. The premiums are spreading the risk of loss over all customers so that premiums can stay low for everyone. With everyone paying, the risk of the insurance company losing money is lowered.


A good example of this is to look at flood insurance. The premiums on this type of insurance are relatively high compared to others because insurance companies have a relatively low number of customers that need this type of coverage, and those that do need it are living in an area with a high risk of flooding. Because of this, insurance companies need to cover the potential loss due to floods by maintaining a high premium. If the companies started adding flood insurance to all customers no matter where they lived, the premium would go down, due to the risk being spread over many more customers that are not potentially living in a flood area. These people would be paying the premium for a service they more than likely would never need, which is basically money in the bank for an insurance company.

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