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Insurance Basics

In simple terms, without the jargon, what is Insurance?

Insurance can be seen as a way to manage risk. Falling within the wider parameters of Risk Management, Insurance is actually the final phase, where risk is ‘transferred’ by an individual (or business) to an insurance company.

How can you ‘transfer’ something intangible like ‘risk’, did I hear you ask? Let’s explore this further. In life, we are all exposed to risks of incidents and accidents occurring, all be it to varying degrees. In most instances, it is difficult to foresee (unless you have a reliable crystal ball) which one of us will suffer a loss or damage as a result of our exposure to a particular risk. Low exposure to a risk does not necessarily mean you won’t suffer a loss as opposed to a person with high exposure. In other words, we cannot relax while spouting the clichéd…“what are the odds of it happening to me?”

To take the guesswork out of the equation, Insurance was designed as a mechanism to protect an individual (or business), not from the unfortunate event occurring, but from the resultant catastrophic effect and/or negative financial consequence.

An insurance company, therefore, collects premiums from a group of at risk persons, in a specific risk category, and places them (the premiums that is) in a ‘pool’. The funds in the pool will then benefit those within the group unfortunate enough to have an accident and/or suffer loss. The premium paid by each individual bears no resemblance to the amount payable by the insurance company from the pool, but because there are a number of other contributors to the larger pool, adequate funds are available for the unfortunate few that need it. It’s similar, in principle, to the traditional, informal ‘Partner Plans’ in the Caribbean.

How do the insurance companies know how much is adequate for each pool? With enough data, over many years, it’s possible for insurance experts to know roughly how many people are likely to experience setbacks, and how much it will cost to recover from them. Using this information, an insurance company can spread the risk among all its customers at a premium that will sustain the pool for the potential benefit of all contributing policyholders.

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