What Is The Connection Between Risk And The Insurance Company?
Free Insurance Quote Comparison
Secured with SHA-256 Encryption
UPDATED: Sep 15, 2020
It’s all about you. We want to help you make the right legal decisions.
We strive to help you make confident insurance and legal decisions. Finding trusted and reliable insurance quotes and legal advice should be easy. This doesn’t influence our content. Our opinions are our own.
Editorial Guidelines: We are a free online resource for anyone interested in learning more about legal topics and insurance. Our goal is to be an objective, third-party resource for everything legal and insurance related. We update our site regularly, and all content is reviewed by experts.
Insurance is a contract between the insured (you) and an insurance company that protects against the risk of large catastrophic loss. If a light bulb burns out in your hallway, that’s a small loss. If an electrical fire destroys a room, that’s a large catastrophic loss.
Insurance companies gather groups of people that share homogeneous risks. The probability of loss is determined across the group as a whole. By spreading the risk of loss across the entire group, each member contributes a small known loss (in the form of a premium payment) in exchange for protection against a catastrophic loss. Should a covered loss occur, the insurance company pays money.
In its essence, insurance is a risk transfer device — moving risk of loss from individuals to the insurance companies. Insurance companies determine the probability of loss across the entire homogenous group, add the cost of administration, and spread the estimated expected losses across the group by collecting a premium from each member of the group.
Homeowners are one such homogeneous group. All homeowners face similar risks, such as loss or damage to the home, loss or damage to its contents, and liability for injury or harm to third parties who come to the home. It is insurance company actuaries who determine what it will cost to pay all the losses the group is expected to incur, factor in administrative expenses and profit, and decide how much each member of the group must pay for the insurance.