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What Is Insurance?

Everybody knows what insurance is, right? Maybe you do, but when is the last time you tried to explain it to somebody? If you had to explain it, how would you do?

Insurance agents like us deal with insurance all day, so asking one of "What is insurance?" might be a bit like asking a fish "What is water?" The fish would probably have to stop and think for a minute.

One simple way to explain insurance would be to say that insurance is a way to transfer financial risk away from you and on to somebody else..

What do we mean by financial risk, and why do you need to transfer it? Read on.

What is risk?

First of all, let's define risk. Risk is the possibility that something bad might happen.1

There are lots of bad things that can happen in the world, so the world is full of risks. Insurance can help with some risks, but not others. For example, when you go to the bathroom, there's a slight risk that you might forget to zip up your pants before coming out, and people will see you, and you'll get embarrassed. That would be bad, and I would feel sorry for you, but, as your insurance agent, I would not be able to help you manage that risk.

The kind of risk that people like me can help with is financial risk; that is, the risk that you could lose some money.

For example, when you drive your car, there's a small chance that you will have an accident and damage your car. It's not certain that you'll have an accident, but it's possible. The probability is greater than zero. Since cars cost money to repair, then the risk of damage to your car is a financial risk, and therefore and insurable risk. If you get physical damage insurance on your car, then the insurance company will pay to repair your car in the event of an accident. By purchasing a policy with that kind of coverage, you have transferred the financial risk of the loss of your car away from you and onto your insurance company. You can keep driving your car, and the insurance company will keep the risk.

Of course, physical damage to your car is only one kind of financial risk. There are many other kinds, and the scariest of those is called liability.

Liability is the state of being responsible for something, especially by law2. If you cause harm to someone else, you are responsible for paying their hospital bills. If you damage someone else's vehicle, you are responsible for paying for it. The reason this is scary is that you can incur a liability that's higher than the amount of money you have in the bank. What if you only have $10,000 in the bank, but, while driving your car, you cause $20,000 worth of damage to someone else's vehicle? Do you know how much of that $20,000 are you responsible for?

All of it; all $20,000.

This is why insurance is so important. In the normal course of your life, you can take on many financial risks that are larger than your ability to pay for them. You can choose to retain those risks, or you can sit down with an insurance agent, identify those risks, and together come up with a plan for transferring them. That's what we're here for.


1. Guy Fox History Project Limited. How the World Really Works: Insurance at Lloyd's of London. Guy Fox History Project limited, 2012, p. 6


Posted 11:36 AM

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