Insurance is one of the largest industries in the world today, yet the fundamental premise of the industry is, at its heart, quite simple. Essentially, insurance and insurance premiums are centred around the idea of risk. Individuals and companies want to reduce the risk they are exposed to, and insurance companies package thousands and thousands of insurance contracts up as bundles which hedges their own risk and allows them to calculate the premiums to charge.

The funny thing is, when someone takes out an insurance policy, they’re effectively betting that some form of disaster or personal loss will occur. This seems pretty counter intuitive right? I mean, who actually wants a personal loss to occur? Well, people don’t have the initial desire to actually at this to occur. But by taking out an insurance policy, they are effectively anticipating in their own minds the possibility of it occurring. In order to make taking out an insurance policy a rational thing to do, the purchaser thinks in their own mind that there is a higher risk of the event occurring. Yet for an insurance firm to be profitable, this cannot be so.

Insurance policies therefore operate around a simplistic structure. For a given fee the insurer creates a promise to repay in full. It is worthwhile for both parties; the fee or premium that the insurer charges is based upon the probability or livelihood of an event happening plus their own profit margin, whilst the individual covers for a potentially devastating loss.

Take home insurance for example: the risk of a house burning down might be minimal, and the fee accordingly so when compared with the total cost of replacement, yet it is worthwhile for the purchaser to take out insurance and pay the premium because in the event of the house burning down the burden of the cost cannot be suffered by the individual.