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How does insurance work ?

  The basic concept of insurance is that a company, the insurer, offers a guarantee for a certain risk that may or may not occur. Then another party, the insured, pays the insurer in exchange for protection against that risk. When a bunch of people do the same thing for the same risk, eventually the insurer is getting a lot of income, but the probability of that risk happening is spread out among a bunch of people and stays about the same.

 Insurance companies make money by figuring out how much money they need to bring in to turn a profit on a given risk with a given probability. That calculation then influences how much each of the insured pays each month. In general, it's simple math, but in actuality insurance companies have highly complex models for all of this.

 Not every insurance company offers the same insurance. Most insurance companies will specialize in their own kind of insurance. This is because each company has to develop a complex model to ensure that they can make money, ensuring a profit. You might be wondering though, why wouldn't you just want to save your money each month, get to hold on to it in a bank account, then if nothing bad ever happens, you have a lot more money. Well, while that may be true, it makes you the one exposed to the risk.


 When an insurance company wants to buy insurance on their own insurance policies, well, then they buy something called reinsurance. That is not a joke. Say an insurance company realizes that they're overexposed to home fire insurance and a hot summer is coming up while they could take out reinsurance policies on their insurance policies to protect them from high losses in case all their houses they insure just burst into flames because global warming and whatnot. Then all the risk is all on the reinsurance agency. This is a necessary thing to think. If an insurance company insured everyone in Florida's cars, but then a hurricane came through and destroyed all the cars, well that insurance company may owe more in payouts than they have. And once they run out of money, well then no one would get money for their destroyed car like they thought they would. Reinsurance is necessary and important to ensure that insurance companies remain profitable and solvent to pay insured when there are claims. In terms of claims, insurance companies also don't just automatically pay out. 


If you have car insurance and you show them a crashed car, the insurance company will investigate to make sure that you didn't intentionally crash your car to get the payout. If they find out that you did do that, well, that's called fraud and you can go to jail. Faking insurance claims actually does happen quite frequently. People see it as a way to either get a big cash windfall if they're in hard times, or get out of a car or house payment that they can't afford.


 

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