Insurance Explained for The Layman

Accidents happen. No matter how careful we are- things can go wrong beyond our control. This may result in damages or injuries that may be too expensive for us to fix. 

[example of cost]

When we buy insurance, we're paying a company little by little over time for the promise that if damages arise, then they will step in and be the one to pay the usually enormous bill. 

 

How Insurance Works

So how exactly can this company pay for all these bills when we only pay them a small portion of the damages we cause? Where do they get enough funds and how are they still in business?

The company doesn't only promise to pay for your damages. They also promise hundreds of thousands of other people that their damage claims will be paid for. However in reality, only a small percentage of those people will really be involved in an accident. 

Let's say, a million people pay the company $1 each for the entire year in exchange for the company's promise to pay for accidents that happen within that specific year. That company collects $1 million in total. 

Within the span of the year, 300 people get into accidents. If the total cost to pay for all those accidents are less than 1 million, then the company makes a profit for that year.

The company is betting that not everyone will be involved in an accident and that the cost of accidents they have to pay for will be less than the money they receive from everyone in total. This is called spreading the risk.

 

A Closer Look into The Promise

Of course, the company will not always foot the bill every time something goes wrong. Their promise of paying the bill comes with 2 main conditions:
1. The event must be an accident
Hurting someone or damaging something on purpose is considered a crime. The company will only pay for damages that were beyond your control like natural disaster damages or for damages that you did not mean to do. 
2. The event must occur in the future
It would be unfair for the company to promise to pay for 

On top of these conditions, each company has its own restrictions of which damages they will actually pay for and up to how much they would pay.

[example of restrictions here]

 

The Benefit

Despite all the restrictions, 

 

Insurance is our financial safety net. We can sleep well knowing that if we do fall,