How Insurance Works

Over the years, the rationale behind purchase of an insurance product has evolved a lot. And still, many a times policyholders keep figuring out what is insurance, how it works, why an insurance company does not return the premium if the insured does not die in case of term insurance, etc. In this article, we shall explain the whole concept of insurance in a very simple and lucid way. And after reading this article, you will be even able to decide which product you should buy based on your needs.
Insurance is a typical arrangement where 'many' individuals come together to cover the losses of a 'few'. Let's take a very simple example to explain this statement.
Let's say there are 200 members in a group of individuals working together. This group predicts that each year, 4 persons will die from it. The economic losses that the families of these 4 members will face after their death will be $ 50,000 each. However, no one knows who will be those 4 individuals who will die. Hence, in order to safeguard the financial interest of their families, each member contributes $1000 towards a common pool created by these members. The pool will then have $2,00,000. If in case of death of those 4 members, this pool will used to distribute money among the families of those 4 members. So, if we look at in other terms, each member safeguards his/her family members' financial interest of $50,000 by paying $1000.
And in actual terms also, this is how insurance works. No one in this world can tell when he/she is going to die. So, an insurance company helps individuals to come together, form a group, form a pool and asks each individual to contribute in to it. More the amount of money the members contributes, higher will be the amount his/her family will get in case of his death. This concept is a true portrayal of a term insurance product and this is why insurers never refund the premium in case of a pure term insurance product in case the member survives throughout the term of the policy. In case of traditional products, insurance companies increase the amount of this minimum contribution so that each member gets some amount if in case he/she does not die.
I'm sure by now you must have been able to understand how and why insurance came in to existence and how it works.