What is insurance

Life insurance or an insurance is an agreement to secure a financial loss, which may result due to the occurrence of a pre-specified event.

Consider the following example:

A farmer had seven sons. All his sons would give him some money at every crop harvest, which he would keep aside. His reasoning was that if any of his sons died prematurely, he would use the money collected to take care of the son’s family. In essence, the father was playing the role of an insurer/insurance company.

Modern-day insurance works on this principle. Individuals pay an annual premium to insurance companies. When individuals die, a predetermined amount is paid to their dependents as nominated by them.

That said, insurance is now a giant industry, and it is not limited to covering risks pertaining to life but also health, home, vehicle, travel and so on.

You may be wondering how insurance companies make money. Firstly, they collect premiums from a large number of people. Only a few of these people may actually suffer the loss. Also, premiums collected are a little more than the expected risk. Secondly, insurance companies invest the money they collect. And, since the collection is immediate while payments may have to be made to customers at a future date, they end up making money.

Now, apart from the customer and the insurance company, there’s another player in this whole business known as the ‘insurance agent’. These agents sell insurance policies to individuals and they make a commission on the premium collected by them. These commissions are quite hefty since selling insurance requires a lot of effort.