What is insurance?

Insurance is based on a simple idea: bad things are unlikely to happen to you on any given day, but very likely to happen to someone in a large group over time. If everyone in the group chips in a small amount, and that pool of money goes to whoever has the misfortune of needing it, everyone gets protection at a reasonable cost.

How does a real insurance company work?

You pay a regular amount called a premium. The insurer collects premiums from thousands or millions of customers. When you make a claim — something covered by your policy goes wrong — the insurer pays out from that pool. The insurer's job is to calculate how much premium to charge so that the total collected exceeds the total paid out, leaving a profit. They employ mathematicians called actuaries to calculate these risks with great precision.

Why do premiums vary so much?

Because risk varies. A 17-year-old learning to drive statistically has more accidents than a 45-year-old with 25 years' experience. So car insurance costs more for young drivers — they're statistically more likely to claim. A house in a flood zone costs more to insure than one on a hill. An extreme sports enthusiast pays more for life insurance. The premium reflects how likely you are to cost the insurer money.

What's an excess?

Most policies have an excess — an amount you pay yourself before the insurance kicks in. If your excess is £250 and your claim is £1,000, you pay £250 and the insurer pays £750. Excesses exist to discourage very small claims (it's not worth claiming for something cheaper than your excess) and to ensure you have "skin in the game," reducing careless behaviour.

Insurance is based on a simple idea. Bad things are unlikely to happen to you today. But they will probably happen to someone in a big group. Everyone in the group pays a little money. This money goes to whoever needs help. Everyone gets protection for a small cost.

Imagine 1,000 families in a town. Every year, one family's house burns down. It costs £100,000 to rebuild a house. Each family puts £100 into a shared money box every year. The box has £100,000 - just enough to rebuild one house. Nobody knows whose house will burn down. But everyone gets protection for just £100. They don't have to risk losing their whole house. That's how insurance works.

How does a real insurance company work?

You pay money regularly called a premium. The insurance company collects money from millions of customers. Sometimes you make a claim. This means something bad happens that your insurance covers. The company pays you from all the money collected. The company's job is to work out how much to charge. They need to collect more money than they pay out. They make a profit this way. They use special maths experts called actuaries. These people work out the risks very carefully.

Why do people pay different amounts?

Because some people have bigger risks than others. A 17-year-old learning to drive crashes more than a 45-year-old driver. The 45-year-old has been driving for 25 years safely. So young drivers pay more for car insurance. They are more likely to make a claim. A house near a river costs more to insure. It might flood more than a house on a hill. Someone who does dangerous sports pays more for life insurance. Your payment shows how likely you are to cost money.

What's an excess?

Most insurance has an excess. This is money you pay before the insurance helps. Your excess might be £250. If you claim for £1,000, you pay £250 first. The insurance company pays the other £750. Excesses stop people claiming for tiny problems. It's not worth claiming if it costs less than your excess. It also makes you more careful with your things.

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