The Theory Behind Insurance

Few things reinforce the power of the American Dream like seeing a young family out on a Sunday afternoon picnic at the lake. The pride on the mother’s face as Dad plays ball with the kids makes anyone who sees it smile. Of all the things that she might think about that afternoon, life insurance probably isn’t one of them.

That is one of the characteristics of insurance that requires understanding to overcome. It is a challenge to think and act on a subject we hope is never relevant to our lives. In fact, the theory of insurance relies on the probability that most of the people who buy it won’t need it.

Sharing the Risk

For that statement to make sense, it is helpful to understand the concept of shared risk. The basic idea is that a large group of people come together to share the risk of something happening to one or a few of that group. When that happens, everyone pays a small amount of the costs. With this approach, no one person bears all the costs. For example, the risk of any one house burning down in a given month is small. It is the same for a healthy father. It’s just not statistically likely that he will die this month or next.

The reality is that houses do burn down and young fathers die every single day of every week and month. Without insurance, the costs of the fire or the loss of the father is devastating financially.

However, if those individuals are part of a group paying a small amount every month for homeowners insurance or life insurance, shared risk means avoiding financial disaster. The pooled money of all those individuals sharing risk means that funds are available to lessen the effects of the loss.

The family that lost its house gets a check to build a new one because their insurance covers the cost. The mother who has to raise the children of that father can do so without financial strain because of life insurance.

There is little chance that the family at the lake will lose the father that day. Because the risk seems small, it is easy not to worry about life insurance. But because families do and will lose fathers, it is important for young families to share the risks of loss with other young families. Just knowing that protection is in place will make a picnic all the more enjoyable.