Most people are familiar with the basic concepts of insurance. Even so, most people cannot actually offer a straightforward, rigorous definition of what it truly is. At its fundamental level, insurance is a form of risk management. It is used in order to guard against the effects of an uncertain loss. In other words, it is the transfer of risk from one entity to another in exchange for money. The two important entities regarding the process of insurance are the insurer and the insured.

Essentially, the insured wants to protect themselves from a specific type of loss. This loss may or may not occur. In other circumstances, such as in the case of life insurance, the loss itself may be certain, but the time of occurrence may not be. In order for an individual to sign up with an insurer that provides them with the best possible value, it is important for them to undergo affective risk management.

The basic concept of insurance is that the cumulative funds of a large number of people can be used to pay for the losses that occur for some of the people who take part in it. The premiums that the insured pay to the insurer are based on the risk of the given event occurring.

The job of an insurer is to access the risk of a particular event occurring for any given individual, determine how much the event will cost, and then charge an acceptable premium. Using sophisticated risk analysis techniques, the insurer can determine the average expenses incurred by each individual. Once this value has been determined, the insurer can then charge a premium which is greater than this amount.

Most insurers do not base the premium off of a strict average of all insured members. Instead, they will tend to assess the risk of each individual and charge a different premium based on their level of risk to the company.

In most cases, an insurer basis its strategy off of the law of large numbers. While an individual could theoretically predict their likelihood of a given event occurring, they would not be able to use this information in order to financially guard against the problem on their own. Things are different for an insurer, however. The larger the group of people involved with the insurance company, the closer the actual losses will be to the predicted losses. In other words, the more people involved with an insurer, the lower the risk faced by the insurer. This allows the insurer to make more accurate decisions about how to effectively charge premiums.