If insurance coverage is non-existent, the victim, the perpetrator or even the victim’s employer becomes subject to a substantial financial burden.  Since there are a lot of risks, everybody will find and agree that being financially prepared for every possibility is almost always impossible.  One can never collect and save enough money to insure against every possible tragedy.  Unpredictability makes preparing even more difficult.  One can never tell what disaster will be visited upon him so there’s no way of accurately determining which event he would need to prepare for first.

Insurance companies provide a resolution to these systemic difficulties that spring from the unpredictability and multiplicity of risks.  The business of insurance is conducted mainly by insurance companies, and the main thrust and goal of insurance coverage is risk management.

Insurance companies provide the mechanism and system of spreading each person’s financial burden to a multitude of policyholders.  The insurance policy holders periodically contribute a fixed amount of money, the insurance premium, to a general pool of funds held and managed by the insurance companies.  These insurance premiums become part of the general funds and are usually nonrefundable.

In exchange for the non-refundable insurance premium, the insurance policy holders get the protection from the events covered by the insurance scheme.  This is because the insurance company will have large funds of money that will be used to recoup any financial losses that they may incur from this said event in accordance to the insurance policy terms and conditions.

The Practicality of Taking out Insurance - A Simple Illustration

In a very simple illustration, say we have a person named Joe whose house and contents are worth US$1 million.  To be adequately prepared for his house burning down, Joe needs to have at least the same amount of money or more.  He would be able to get his house rebuilt or repaired while at the same time be able to live comfortably while the rebuilding or repairing is underway.

Say Joe did not want to take out a homeowner’s insurance policy, yet he still wanted to be prepared just in case.  Joe has a job that pays US$100,000 annually and he proceeds to set aside $25,000 every year for his “personal house insurance fund.”  In this scenario, it will take Joe approximately 40 years to come up with this amount of money.  By the time he gets the money, the event he has been saving up for, namely his house burning down, may have already happened.  In any case, he wouldn’t have been fully prepared for his misfortune.

On the other hand, let’s say Joe took up a homeowner’s insurance.  Joe took out a US$1 million home insurance policy that requires him to pay a monthly premium of $300.  Joe, being the conscientious personality that he is, never misses an insurance premium payment.  One year after taking out the policy, his home burns down.  In this scenario, Joe’s insurance company will reimburse him for his losses as per the terms of his insurance plan.

Let’s look at the particulars of this second “insured” setting.  After only a year of paying insurance premiums, Joe is reimbursed for the full amount of his policy worth US$1 million.  By this time, he has only made payments of approximately US$3,600.  This means that by acquiring insurance coverage, Joe obtained for himself a useful and immediate home protection without the need to personally come up with the full amount of money required.

Joe’s insurance company will have immediate funds to cover the losses.  This is because there is a large pool of funds that have been collected from other insurance policy holders.  The money the insurance company will pay in this example is, in actuality, do not come from Joe’s US$3,600 total of insurance premiums.  Rather, it will come from the collective amount of insurance premiums from Joe and other clients.

On the other hand, if Joe’s house never burned down even if he held a policy to specifically insure against this incident, Joe would not at all be able to refund his insurance premium contributions.  By being an insurance policy holder, he gave the insurance company the right to use the said amount to recompense for the losses of other policyholders whenever the houses of these people burn down.  In this case, he had lost his insurance premiums to the insurance company.

In the final reckoning of things, however, Joe wouldn’t have lost much money.  In the 40 years when he would have had to come up with his house fund of US$1 million if he did not take out an insurance plan, he would have contributed only around US$144,000 in insurance premiums.  This is not such a bad deal considering that he was always insured against a US$1 million loss all this time.

The point to Joe’s story, ladies and gentlemen, is that alone, a person will find it very hard to shoulder the financial burden of protecting himself against a calamity or a disastrous event.  Through an insurance policy, many people contribute to a general fund so the financial risks are spread to a lot of people and are thus effectively minimized.  In truth, an insurance policy holder shoulders only a fraction of the total cost he would have borne alone if he were without insurance coverage and the calamity that he desired protection against ever came about.  Therefore, taking out an insurance policy makes practical sense.  In line with this, let’s now look at the variety of insurance options that every consumer can choose.