How insurance works

0:01- Let's say that you have a car that right now is worth about $10,000 and you don't have $10,000 as a cushion. If by chance your car were to get totaled or if it were to get stolen or something were to happen to it, you don't have an extra $10,000 to then buy another car just like it.

0:19So one option you have to try to transfer some of that risk is to buy car insurance. And this video is about all forms of insurance, but I'll just use that as an example to just help think about how insurance works. So what's going to happen in that situation is that you would likely go to an insurance agent and you're just, like, "I would like to insure my car in case it gets stolen, in case it gets totaled, in case something bad happens to it and I have to pay a lot of money for that."

0:48And so then the agent, they might work for an insurance company or they might be able to get you quotes from many different insurance companies, but they'll come back to you and say, "Okay, if you pay $200 a year," and I'm making up these numbers, these aren't necessarily the types of numbers that you will see when you when you go to an insurance agent.

1:07"But if you pay $200 a year, we got you covered. If anything were to happen we will cover the cost of the car." You're like, "Okay, I do. I can pay $200 a year," and I'm willing to pay $200 a year because I don't have $10,000 if something bad were to happen, so I agree to do that.

1:26Now the question you might have is, "Well, how does the insurance company make money here?" Well, they have a whole bunch of people looking at the statistics of it all, statisticians, they're usually called actuaries when they're at an insurance company, and they look at the probability of something like that happening.

1:40So let's say they decide that there's a 1% chance in a given year that they are going to have to pay out $10,000. Now, if it was just one person, and in that if you're the only person they insured, and in that year you paid $200, but they had to pay out 10,000, that's not that good of a business, (chuckles) or at least for that year they would've obviously lost a lot of money.

2:02But the way the insurance companies work through it is that they're actually insuring millions of people and they're working on percentages. So for example, if across millions of people, all of them are paying $200 and there's a 1% chance of having to pay out $10,000, well that means on average 1% of $10,000 is $100, on average, they're gonna be paying out about $100 per insured person who's just like that, and if they're getting $200, well then they're going to be on average making about a $100 profit.

2:35People are paying $200, that's called the premium, what you pay the insurance company, and then their actual statistical cost is $100. So that's how they would actually make money. Now, let's say one of these bad scenarios happens to you, your car gets stolen, it gets totaled in some way, well, then you would make a claim to your insurance company, usually, someone there would then investigate the claim if you made a police report they would take a look at that, they would interview you, make sure that you're not committing insurance fraud, which is like, you know, you made the car disappear but it really didn't disappear.

3:09Don't do that, highly, highly illegal, you will get into trouble for that. But then if it's a legitimate claim then they will then make the payout to you. So think about insurance, but also think about, you know, how they're benefiting and how you can benefit.

3:24And also try to shop around for different types of insurance policies. You'll often see some pretty dramatic differences in the price of the premium, that's that $200 a year that I just talked about.