Ariel Munin

Insurance in Simple Terms - The Essence

26/06/2011

Insurance has always been considered a boring and incomprehensible topic. Complicated terms, such as compensation, subrogation and exaggeration, appear in small print in dozens of sections and sub-sections densely covering dozens of pages of the insurance policy. Even the words of the insurance policy are unclear to the ordinary person.

In the coming series of articles, I will try to explain the world of insurance in a simple and interesting way.

What is insurance?

We all understand that if, unfortunately, an incident occurs which causes damage to property (through burglary, flood or fire in the house, car accident or theft),  the financial consequences can be considerable. This kind of incident, of course, happens suddenly and is unexpected.  No one can be prepared for it or avoid it. The risk of such extensive damage raises the question: Is it at all worthwhile to own uninsured property? For example, imagine a person who buys a new car with his life’s savings. How can he cope with theft or accident without insurance? Without the option of insurance, many of us would prefer not to take the risk of buying a car at all.

Insurance is basically a socialistic idea. An individual who wishes to insure his assets, agrees to pay a fixed sum of money (the insurance premium) into a shared fund (the insurance company) backed by a written contract (the insurance policy).

The contract stipulates that in case of damage to property, the company will pay the agreed amount, i.e., the company that collected money from many individuals who insured their property, will pay out to each individual who can prove he has been damaged. It is clear to those insured that if no damage occurs, no money will be returned. That's the socialistic idea: all for one and one for all.

Insurance acts as a mechanism to manage and hedge risks. In risk management, a fixed sum of money is collected in advance sufficient to cover claims to payment of those whose cars are stolen. If the planning is poor and too little is collected, then when an insured individual tries to make a claim, the answer will be: "Sorry, there is no money left for you", and the whole system will collapse.

The insurance company must also determine and define the extent of risk it can take on itself. Thus, for example, in the case of a catastrophe,--an extensive fire in a large city in which hundreds of thousands of cars are destroyed—the company must itself be insured. This subject will be discussed later on.

In conclusion, the insurance policy provides the individual the most basic security for his assets. Without insurance, investments would be unstable and dubious, open to loss. The insurance company is the mechanism that protects the public’s money in a shared fund and pays out only to those who have truly suffered damage. Insurance is important to risk management for the individual, the commercial enterprise or any other economic entity.

*Translated by Elsa Hadar

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