What are the Principles of Insurance?

Without wanting to blow our own trumpet too loudly, it’s true that in many ways, the world would not operate as it does without insurance. After all, who could afford to own expensive property if they could not insure it against disaster?

Likewise businesses could not afford to take the risk of major infrastructure investments if they were faced with the possibility of financial devastation if the property was totally destroyed in a natural disaster. Like it or not, insurance makes it possible to own property, to embark on travel or to start a new enterprise and it does so by a process called risk spreading. The world of insurance, like all financial institutions is increasingly complex and it involves numerous parties with vested interests. But at its core, the concept of insurance is relatively simple and has never fundamentally changed.

Learn How Insurance Works 

It can best be explained using the example of the street you live in – wherever that may be. The owners of the houses in your street have invested heavily in property ownership, many will have borrowed to achieve this ownership. Now, if any of the owners were to suffer a total loss from, say,  a fire or a flood, would they have enough savings to allow them to re-build their home – or, if not, could they get another loan to start over again when maybe they still owed money on the home that was lost?

The answer, is probably not.

Yet an insurance company can cover this risk and pay for the rebuild despite having only ever received a fraction of the homes replacement cost by way of premium from the owner in question. The way insurance works, of course, is that insurers cover many, many homes – all the homes in your street, not just the one that was destroyed and they all pay a ‘premium’ which creates a claims fund, or a pool of money which is made up of all those accumulated premiums. Anyone unfortunate enough to suffer a loss can then dip into that pool to make good their loss, even if the amount they take out is many times greater than the sum they personally contributed. The insurers hope of course that only a small percentage of those paying premiums will need to dip into the pool at any given time. And if those claims increase in number or volume, then of course the insurer is obliged to increase the amount (the premium) each member must contribute to ensure there is always enough in the pool to pay anticipated claims.   

We’ve used the example of a home, but the principle is more or less the same whether it’s a piece of property, a person’s health or even the future profits of a business. Provided an insurer can get enough people contributing enough premiums to its claims pool, there is very little in this world which is not insurable – and that’s just as well because life (& death) would not be the same without it.

So, now you know!