How Does Insurance Work?

Before we get to that, just a quick question...

How do you shut down a conversation with someone?

Answer: Simply tell them you are a Financial Advisor! 😅

They will get off the conversation at the speed of light and never come back. 😔😅

I guess the stigma has been like this for ages.

In other countries, insurance is a must-have.

They are the ones getting visited by people.

But in our country, it is them who visit people and oftentimes are unwelcomed, rejected, or ignored.

But why do we need insurance?

How does it even work?

If we talk about basic necessities, we only need food (including water), shelter, and clothing. We can live without insurance. We don’t need it to literally live.

But in times of unfortunate events, you will certainly wish you have one. You will need it.

This may be the liveliest video I have ever watched that explained how insurance work in the simplest and easy to understand terms and visuals:

As what was said in his intro (if you are lazy to watch), Insurance is a necessity that we all pay for to make sure we don’t end up in massive amounts of debt if our house burns down, if we crash our car, or if something tragic happens.

In the simplest term he explained, insurance helps us maintain peace of mind, knowing that even if something bad does happen, someone else is going to pay for what it costs to fix it. Though, to an untrained eye, this can be a little perplexing. I mean, if you pay $200 a month for home insurance and after only 6 months your home burns down, the insurance company will buy you a new house, likely in the manner of hundreds of thousands of dollars. But, you would’ve only given them $1200. Why would they do that? That’s the power of insurance, baby. 😁

The basic concept of insurance is that a company, the Insurer, offers a guarantee for a certain risk that may or may not occur.

Then another party, the Insured, pays the Insurer in exchange for protection against that risk.

When a bunch of people does the same thing for the same risk, eventually the Insurer is getting a lot of income.

But the probability of that risk happening is spread out among a bunch of people and stays about the same.

Insurance companies make money by figuring out how much money they need to bring in to turn a profit on a given risk with a given probability.

That calculation then influences how much each of the Insured pays each month.

In general, it is simple Math but in actuality, Insurance companies have highly complex models for all of this.

Not every insurance company offers the same insurance.

Most insurance companies will specialize in their own kind of insurance.

This is because each company has developed a complex model to ensure that they can make money.

If you estimated that 1 in 100 houses burn down each year but it was actually 5 in 100, then you'd be losing money really fast if you insure those houses.

You'd probably charge too little for everyone's insurance and then end up on the hook for those 4 extra houses.

There are many types of insurance companies, from auto to health to life to homeowners.

Most people in the world have these core insurance policies, some of which are legally required to be held like auto insurance.

You might be wondering though, why wouldn't you just want to save your money each month, get a hold of it in a bank account then if nothing bad ever happens, you have a lot more money?

While that may be true, it makes you the one exposed to the risk.

If you put away Php 10,000 a month for a year to save on home insurance, you will have an extra Php 120,000 at the end of the year.

However, if your house burns down the next year, then you are going to be out a few hundred thousand to fix it.

Is that a risk you are willing to take?

Chances are, it isn't.

That is why getting insurance is generally a good thing.

It takes all of the risk and anxiety and financial burden off of you and puts in on a much larger company that can afford it.

When you understand insurance as just a way of paying a company to assume your risk, you can start understanding that insurance could, in theory, be offered on, virtually, anything.

Further explanation can be learned from the video shared above, plus he talked about reinsurance and insurance claims, all of this in just 8 minutes of your time, well only 7 minutes actually, the rest are random stuff like a suckling kitten. 😉

So now you can likely see, insurance is a big business and if you have the right models, assumed the right kinds of risk, and have good investigators to make sure that you are not defrauded, then you can make a lot of money.

Conversely, if you buy insurance, and something bad happens, it can save you a lot of money.

In most cases, insurance is a winning formula for all parties involved.

It helps consumers be less worried about bad events, and it makes companies a lot of money.

And that's basically how insurance works.

You might think though, what if you buy the insurance and nothing bad happens?

Does the insurance company get to keep the money?

Generally, yes.

Same with life insurance if term insurance is what you buy.

Term insurance is life insurance that provides insurance coverage only for a fixed period of time.

But life insurance actually has a lot of kinds.

I won't go into detail about it in this post, but you can also buy life insurance where you pay for a certain period of time and if you outlive your insurance policy, you will receive the maturity value of what you paid for. 

That is a more winning formula on the consumer's side. 👍

That is what I actually bought last year, specifically, AIA Active Critical Protect 100. 😊

It has a 10-pay and 20-pay policy plan, which gets you already covered until age 100.

If you reach age 100, you will receive the maturity value of your plan.

Don't worry though, if you doubt that you can get to that age, you can terminate it early and receive the cash surrender value of your policy.

Yeah, baby, yeah. 😁

That is it for now.

I hope it kind of given light to how insurance work. 

Be sure to watch the video from "Concerning Reality", it is very entertaining and helpful.

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