ELI5: What is insurance?

Part 1 of the Insurance Onboarding Series; How insurance works, and solidifying the basic terms you've probably heard but don't totally know.

Insurance is how you take a precious thing you own, 
and protect yourself from the cost of fixing it, 
should it be damaged in a particularly rare or expensive way.

(I promise I’m not writing insurance poetry, I just really wanted you to rest on each line of that sentence.)

Insurance is how you take a precious thing you own, 
and protect yourself from the cost of fixing it, 
should it be damaged in a particularly rare or expensive way.

The precious thing could be your phone, your house, your car, or even your health, your pet’s health, your life, your business – all of these things can break in rare and expensive ways, and insurance says “Hey - If you give me a little money every month, if some ridiculous, rare, unlikely happening damages your precious thing, I’ll cover the enormous cost of getting your precious thing back in working order.”

And you might be thinking, “So I just pay this insurance company a little bit every month, and it will pay me back an enormous amount if something rare and expensive happens to my precious thing?”

Yep. And here’s why;

An insurance company has 3 things going for it;

1. It has lots of people that own precious things that are paying them little bits each month.
   
   The insurance company is pooling that money, and even sometimes investing it to make more, for when some rare and expensive thing happens.
   

2. The insurance company has a strong understanding of the likelihood - the odds - that something rare and expensive might happen in a given year.
   
   Right? Like, the insurance company knows that only 1 in 10,000 homes will get squished by a tornado. (Which I made up.) They know what percentage of American men over the age of 70 will get cancer. What percentage of phone screens will get cracked. What likelihood a new, 16 year old driver will get into a car accident. And they use that data to decide what little bit of money - and those are called premiums -  you’ll need to pay them each month, so that when the rare and expensive thing does happen, they have enough money to send the unlucky bastard an enormous check.

And the third, rarely known thing an insurance company has going for it;

3. They might have an even bigger insurance company behind them, called a reinsurer and sometimes even the state government willing to step in if, for example, every home that a home insurer covers has been wiped out by the world’s first hurricane-sized super tornado.

(During editing I was informed there is a movie about a hurricane-sized super tornado, and no, I won’t be watching it.)

The insurer wins because it gets paid lots of little premiums every month from lots of customers, pools that money, invests it, and then pays the one or two unlucky sods that say “HALP! A rare and expensive thing happened!” by filing a claim.

The customer wins because they know that if a rare or expensive things happens to their precious life, business, home, car, dog - you name it - the insurance company will foot the enormous bill. It probably won’t happen, but if it does, it won’t be catastrophic.

Let’s go just one layer deeper into the touchpoints -
the pieces that an insurance buyer actually sees.

The person with the precious thing - what they actually buy from the insurance company is a policy. That policy is just a big, dumb, contract. A stack of papers that says, in legal language, “If this thing happens, we’ll pay for this much. If this other thing happens, we’ll pay for this much.”

That policy sold at a price that’s specific to your precious thing - how much it’s worth, how fragile it is, where it’s located, how well you’ve been taking care of it, how experienced you are as an owner of similar precious things.

That’s why insurance policies have applications. The insurance company needs to collect some information about you and your precious thing so it knows how much to charge in little premiums each month.

Last touchpoint;

When you’re purchasing an insurance policy, the insurance company presents that information on a quote summarizing what kinds of coverage they are willing to offer you, and what price, given everything you told them on the application.

The insurance company can also be like, “Uhh, no. You are too risky. We aren’t collecting enough premiums each month from all of our customers, given the likelihood that you are gonna damage your precious thing in the next year.” And that rejection is fair, but also sometimes discriminatory, which is partially why the government regulates the insurance market. 

That’s how insurance works.

Does that make sense? Holler in the comments if not, because this is the zoomed out base from which we will be zooming in through out the rest of The Insurance Onboarding Series.

Until next time,
(Next time is tomorrow.)
Carrie

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If you’re totally following, and want to start kicking on some interesting questions teed up by today’s post, consider;

• What’s about to happen to insurance companies given climate change is scrambling the the historical odds of a hurricane-sized super tornado wiping out the precious things of ALL of their customers?

• What price would AI choose for coverage, if it was given the application information about you and your precious thing? Would it discover some new source of data that is much more helpful when discerning the odds that your precious thing will break this year? Would it be more discriminatory? Less?

I’m not even going to try to answer these questions in The Insurance Onboarding Series, but insurance is starting to sound a little less boring, no?

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Ready for Post 2? Well it’s ready for you!