How Does Insurance Work?

Video Transcript

"Well, the basic way insurance works is you pay a premium to a company that provides you with insurance, and in the event of a loss, they will provide you some sort of benefit. This could be car insurance, where you're paying a monthly premium. And in the event of an accident, your insurance company will help you cover that loss. This can be homeowners insurance, where you pay a premium and the insurance company will help you cover that loss of a home or damaged property. Same with life insurance. You pay a premium and you die, then it covers your loved ones -- passes on money to them. So basically, the way insurance works is you're paying a premium and the insurance company, in the event of a loss, will pay you out a benefit. Now, an important thing to consider is insurance companies are in the business to make money. So they're making money off their premiums. They have advanced calculations and basically, what they're doing is they're taking your money and they're taking a risk. They're gambling. They're saying, "Okay. I'll take your 100 dollars a month of premium and if you get in an accident in your car, I will give you X amount of dollars to cover you." Now, what they're betting on is that this 100 dollars a month will add up to more than they pay out for your car for the life that you have this type of policy. And that's how insurance companies make money. Generally, what they're doing is they're taking in a ton of risks and they're kind of spreading it around. So maybe they take on 20, 30, 40 people and only one or two of them have any type of auto claims. So they're able to make money by kind of spreading that risk around. Whereas, if they were to take on a smaller amount like one or two, the risk would be significantly greater. Oftentimes, insurance companies will even do something called re-insurance, where there will be another insurance company that will purchase that risk from the insurance company that you go through. So you would go through an insurance company and maybe they would take your policy and offer it to another insurance company as a form of a re-insure. So the insurance company can help reduce their level of risk that they're undertaking by offering this sort of re-insurance through other companies that will take on that level of risk."