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| Definition of Insurance: a system to alleviate financial losses by transferring risk of loss from one entity to another. |
| Synonyms of Insurance: assurance, risk transfer |
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| Insurance is a system to alleviate financial losses by transferring risk of loss from one entity to another.
The entity that is transferring the risk ? which may be an individual or association of any type, including a government or government agency ? is called the "insured". The entity accepting the risk is called the "insurer". The agreement between the two by which the risk is transferred is called the "policy": this is a legal contract that sets out exactly the terms and conditions of the coverage. The fee paid by the insured to the insurer for assuming the risk is called the "premium". This is usually determined by the insurer to fund estimated future claims paid, administrative costs, and profit. For example, let us assume that a couple buys a home costing $100,000. Knowing that the loss of their home would bring them financial ruin, they acquire insurance coverage in the form of a homeowner's policy. That policy will pay them the cost of replacing or repairing their home in the event of a catastrophe. The insurance company charges them a premium of $1,000 a year. Risk of loss has been transferred from the homeowners to the insurance company. The insurer uses actuarial science to quantify the risk they have assumed. Actuarial science uses mathematics, particularly statistics and probability, which can be applied to many covered risks to approximate future claims with reasonable accuracy. For example, many individual people purchase homeowner's insurance policies and they each pay a premium to an insurance company. If a covered loss occurs, the insurer pays the claim. For some insureds, the insurance benefits they receive will greatly exceed the money they have paid to the insurer. Others may never make a claim. When averaged out over all the policies sold, the total of claims paid out should be less than the total of premiums paid to the insurer, with the difference being costs and profit. Insurance companies also earn investment profits. These are generated by investing premiums received until they are needed to pay claims. This money is called the "float". The insurer may make profits or losses from the value change in the float as well as interest or dividend on the float. In the United States, the underwriting loss of property and casualty insurance companies was $142.3 billion in the five years ending 2003. But overall profit for the same period was $68.4 billion, at the result of float. Some people consider insurance a type of wager or bet that executes over the policy period. The insurance company bets that you or your property will not suffer a loss while you put money on the opposite outcome. The difference in the fees paid to the insurance company versus the amount for which they can be held liable if an accident happens is roughly analogous to the odds one might expect when betting on a racehorse (for example, 10 to 1). For this reason, a number of religious groups including the Amish avoid insurance and instead depend on support provided by their communities when disasters strike. In closed, supportive communities where others will actually step in to rebuild lost property, this arrangement can work. Most societies could not effectively support this type of system and the system will not work for large risks. |
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