In its rawest form, insurance is a method both businesses and individuals use to reduce the financial impact of a risk occurring. In other words, if you think you will be in an auto accident for example, you will purchase auto insurance.

Keep in mind the insurance policy does not remove the risk. It is merely the vehicle by which the policyholder gets a measure of security should the worst happen.

There are two parties to an insurance contract. The insurer and insured. The insurer agrees to accept the risk a business or individual, called the insured, would face. The insured pays the insurer a premium for the ability to transfer the risk.

The agreement to perform the above transference is called a policy. It is also called a contract. This is the document that spells out what risks the insurer has agreed to insure against and how much it will pay if the risk happens so that insured is put back into the same position as if the risk had not happened.

Insurance companies have been in business since the 1600’s so they know a thing or two about insuring against risks. Therefore have something called exclusions.

Exclusions are simply things that are not insured against. The policy will actually have a section titled “Exclusions”. With today’s auto policies for example, the insurance companies won’t pay if someone leaves the keys in their car and it gets stolen. The policy will contain a paragraph detailing what the company considers as being careless.

The insurer makes its money from several sources. The best known source are premiums the companies collect. They pool all of the premiums they collect and invest those dollars. Their investments are regulated by law.

Because insurance is insuring against a risk, something called a claim will be made. That means the risk happened and the insured suffered a loss. The company uses this pool of funds to pay on the claim.

The insurance companies are no different than any other business. They are profit motivated. Their hope is total premiums they receive in any one year coupled with any money they make investing will exceed the total claims they have to paid out.