The promise to make good a loss which may arise in future, in return of a periodic sum of money, is known as Insurance. The sum of money paid periodically is known as premium. Insurance allows an individual to secure himself/herself or his/her property, against a significant potential loss at a reasonable rate. Simply put together, an insurance company helps its customers to manage risk, by offering to pay a sum of money on the happening of a pre defined event, for eg. a natural calamity, an accident, etc.
Insurance companies usually earn in two ways:
1. By charging a premium greater than the expected payout that they will have to make.
2. By investing the premium amount, and earning interest on the same.
However in reality, the companies pay back the premium amounts, so that they can attract more and more customers, so the chief source of income for the insurance companies is by the way of interest on investments.
How does insurance work? The insured has to regularly pay the premium to the insurer. In case the condition against which insurance is taken happens, the deceased has to make a claim to the insurer, and the company will pay for the losses covered under the policy. In case the insurer does not make a claim, he/she won’t get the money back. Instead the money is pooled with the premium amounts of the other policy holders.
How are premiums calculated? Insurers use statistical data to ascertain the likelihood of the happening of an event. If the event is more likely to happen, i.e. if the company has more chances to make good the losses suffered by the insured, the premium will be higher.
Thus, the insurance companies run profitably by pooling the risk. This means that there are a large number of people seeking insurance, but not all of them will be claiming protection. Thus, insurance companies use statistical analysis, decide an amount of premium depending upon the probability of happening of some events, pay out the deceased on receiving a claim, and earn profits.