According to Wikipedia, insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment.
Taking out the jargon, insurance is a promise made by one person to periodically pay another person money. The person paying the money is promised by the other person to be paid money when something specified happens. The word “person” is given in italics as it can be interchanged for business, organization, corporation, etc. Now if this was where the definition stopped, you would say that insurance is nothing more than gambling, and some do share this opinion.
Insurance does have an important distinction from gambling in that before you bet on an outcome, you had nothing to gain or lose. But once you place a bet, you will either gain something or lose something depending on the outcome. If it is favorable, you win. If not, you will lose what you have wagered or risked. In essence, gambling is the creation of risk. Insurance differs from gambling in that it is one way to deal with existing risk.
As a child, you may not be aware of the risks that exist around you. As you get older, you begin to see, hear, smell, taste and feel the various risks that exist all around us. As the saying goes, “Life is a risk!” If one stops to consider all of the risks brought on by a “normal” day, you may become depressed and overwhelmed. As a prudent and pragmatic person though, you learn to cope with these risks. If you stop and think about it, the way you deal with each risk falls into one of three categories:
In the next installment, we will take a look at an example that will help describe these risk mitigation techniques.