Eli5: How does insurance work ? How is it a good deal for both the customer and the company ?
In: Economics
So early insurance back in the olden days worked like this. Early insurance came from boats. Boats were used to carry around cargo in the Mediterranean Sea. Being boats from the old times, they were not so well made and would occasionally sink. If you were wealthy, you might own 10 boats, if one of them sinks, you still have the other 9 to earn enough money to cover your losses on the 10th.
But if you only had one boat, and lost it, you would not be able to cover the loss. Insurance was invented where someone, usually a wealthy and trusted person or group of people, would offer a produce where several boat owners would pay them insurance money based on what type of boat they have and what cargo they were carrying.
The insurance company did the math and realized that only about 1 in say 50 boats sank per year year (I don’t know what the real figure was). So if they had 150 boats in their insurance pool they would have to pay out for three of them. An individual boat owner could afford insurance, but could not afford to lose their boat.
Its a good deal for the customer because they could operate their shipping business knowing that if they lost a boat it would be covered. It was good for the insurance company because they would collect more money than they would need to pay out.
Early insurance companies were sort of like banks too. What they figured out was that they could take all the money that they are collecting, and then loan it out, collect interest on those loans, and still be able to have enough income coming in to cover the cost of a lost ship. They would usually have something in their policy that the reimbursement would be paid out after a certain period of time, because they would be collecting interest and loan payments from people who they were lending money to.
For the customer it’s a good idea because in the event of damage or a crash that requires a lump sum available on hand for repairs or replacement the insurance company takes care of it for them. Of course it’s worth noting that since insurance is legally mandated it’s not that great of an idea for anyone who actually has money lying around but they’re forced to get it anyways. They also pay out victims of crashes.
For the company it’s a good deal because they’re betting that they’ll collect a lot more money from premiums than they’ll have to pay out, so it’s a net profit.
So, making up numbers and information to simplify everything.
I pay $100 a month for home insurance. Regardless if I use it or not, I pay them $100 per month.
One day a tornado blows a tree and it comes though a window. I go to the insurance company and they help me cover part of the window, I pay $100 (this is my deductible) and they pay the remaining 500 owed to the window company And then I go back to paying $100 a month.
That is how insurance works. Now things start to get complicated. My $100 a month might be higher if I live in an older house in a Flood zone just because there’s a higher chance of problems.
Or it could be lower if I’m in a newer house with a bunch of safety features (whole house fire alarm and sprinklers for example)
The same system is similar for health insurance, and car insurance. For health insurance, I get a free checkup once a year, and specific things are covered at 80% after I meet my deductible of 2000 per year. But health insurance has the issue of not every doctor accepts their insurance so you might get charged more. This is called out of network.
Car insurance is extremely complicated with multiple types of coverage for multiple scenarios. There’s if the person doesn’t have insurance, if you are at fault, all in one, etc etc.
they also look at your driving record and the car you drive. If i have been in 5 accidents and drive a 2000 car, it’ll be pretty high because I’m a bad driver in their eyes driving an old car.
On the other hand, if I’m driving a brand new car filled with safety features, and have 0 accidents, my rate will be lower as I’m driving a new and safer car and am a good driver.
You pay insurance money and they help cover costs when things go wrong. They charge you more or less if you try to make things “easier” for them and less likely for them to have to pay you money.
Hope this helps!
if it is a health related insurance, it is a two way gamble
you bet you are going to get weird or costly disease in the future, so the insurance can cover your expenses on that. or if you are American, just to cover normal but crazy medical bills
and the insurance company bet on you being healthy and live long
But most insurance company are also investment company. they can benefit a lot by the amount of cash flow collect from customers who brought insurance on monthly payment.
On the other hand, DO NOT purchase any “Saving” insurance. you will get way less compare to what the insurance company can get, it is not fair deal
It’s good for the company because the company is usually correct when they calculate how much money they have to charge vs pay out.
It’s good for a customer if the customer gets compensated by insurance.
The ones that lose money are the customers that never need to make an insurance claim. I.e. the ones that paid for insurance but no event ever happened that they needed to use the insurance.
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