Insurance covers risk, and a risk is anything that could happen that would expose you to loss. Basically, when there’s an asset involved (something of value), there’s also risk.
You can probably think of a bunch of bad things that could happen to your stuff, but in financial terms, you are also an asset (because you have the potential to earn) and therefore a risk (because bad stuff could happen to you that would prevent you from continuing to earn).
Insurance was created as a way of covering people’s risks by paying them (or someone they choose) when bad things happen to their stuff (like something valuable getting damaged or lost) or to them (like getting very ill, injured, or dying). So it follows that the first step to understanding insurance is to identify the different types of risk that it can cover.
Insurance doesn’t cover all the bad things (like if you’re injured while committing a crime), but for the most common and major risks, like your laptop getting stolen, your car being damaged in an accident, being rushed to hospital in an emergency, getting cancer, or dying, there is insurance to cover it.
To protect your assets, you can pay an insurance company a relatively small amount of money every month (called a premium). Insurers are able to cover large numbers of people’s risk at the same time because they rely on the fact that only a small number of their clients will have bad things happen, so they use the premiums they collect from the majority to pay for the minority. In the industry, this is called ‘spreading the risk’. Insurers usually have a bit of money from premiums left over, which they use to cover their operating costs and make a profit. If they didn’t, they’d soon go out of business.
The last thing you need to know about risk is that your risks can change over time. As you get more assets (like a car, a house and a spouse), you also expose yourself to more potential loss. This also happens as you move through different stages of life—from being single to supporting a family—each life stage has its own potential risks, so it’s wise to reassess your insurance cover as things change.
Two of the most common mistakes people make are either not recognising their risks or getting more cover than their risks actually require. These are two sides of the same coin (in both cases the risk is not accurately understood), but if you get clued-up on the facts, be realistic about your situation and needs, and get a back-up plan in case things go wrong, it’s unlikely you’ll fall into those traps.
It’s not about wearing emo-tinted glasses, it’s about protecting the valuable stuff so that you can get out there and enjoy your life.
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