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What Is 'Insurance'?

Insurance focuses on transferring a risk from purchaser to seller in exchange for a series of payments. If something bad happens the insurer is responsible for the bill, and if it doesn't, the insurer keeps the money.

Insurance protects the purchaser from risks they can't mitigate on their own.

Insurers spread risk over a large number of purchasers, and focus on maximizing payments while minimizing claims.

Josh Kaufman Explains 'Insurance'

Insurance involves the transfer of risk from the purchaser to the seller. In exchange for taking on the risk of some specific bad thing happening to the policy holder, the policy holder agrees to give the insurer a predefined series of payments.

If the bad thing actually happens, the insurer is responsible for footing the bill. If it doesn’t, the insurer gets to keep the money.

In order to provide value via Insurance, you must:

1. Create a binding legal agreement that transfers the risk of a specific bad thing (a “loss”) happening from the policy holder to you.
2. Estimate the risk of that bad thing actually happening, using available data.
3. Collect the agreed-upon series of payments (called “premiums”) over time.
4. Pay out legitimate claims upon the policy.

Insurance provides value to the purchaser by protecting them from downside risk. For example, a house can catch fire in any number of ways, and most homeowners don’t have enough cash to purchase another if their home burns to the ground.

Homeowners’ insurance transfers this risk to the insurer. If the home is destroyed by fire, the insurance will compensate the homeowner and allow them to purchase a new home. If it doesn’t, the insurer gets to keep the premium payments.

Insurance works because it spreads risk over a large number of individuals. If an insurer writes policies for thousands or millions of homes, it’s highly unlikely that every single one will burn to the ground at once—only a certain number of claims will have to be paid.

As long as the insurer brings in more premium payments than it pays in claims, the insurer makes money. Car insurance, health insurance, and warranty coverage for consumer goods works the same way.

The more premiums an insurer collects and the fewer claims the insurer pays, the more money it makes. Insurers have a vested interest in avoiding “bad risks,” maximizing premiums, and minimizing payments on claims.

Accordingly, insurers must be constantly vigilant to avoid fraudulent activity, both in terms of preventing fraudulent claims and by itself defrauding purchasers by collecting premium payments without paying legitimate claims.

If an insurer fails to pay legitimate claims, they’re likely to find themselves in court as policy holders use the legal system to uphold their insurance contract.

Questions About 'Insurance'

• Does delivering value via offering insurance make sense for your business idea?
• If so, what do you need to plan for to make it successful?

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"Take calculated risks. That is quite different from being rash."

General George S. Patton, commander of the U.S. Third Army in World War II

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https://personalmba.com/insurance/

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