Does it sound incredible for you when an insurance company charges a 30 year old person $25 monthly for a $200,000 term life insurance policy? In this article we'll clear up this mystery and show that without going into details insurance is not so complicated as it may seem.

Insurance is a powerful economic device that plays an important role in modern society. Typically under insurance we understand a certain way of risk management. Thus, before we look deep into the insurance basis we should be clear about what the word "risk" means.

Usually, where there is risk, there is uncertainty about an adverse outcome. But such definition is a bit obscure and doesn't explain how do we actually evaluate and manage this "uncertainty". In the insurance industry under "risk" it is customary to understand "a condition in which there is a possibility of an unfavorable deviation from an expected outcome". Risk is related to the actual financial loss, and therefore is measurable. Degree of risk is the probability of the unfavorable event occurring, whereas magnitude of risk is the amount of the likely loss.

Risk can be managed in several ways. For instance, an individual or a company may avoid risk by not engaging in any form of hazardous enterprise at all. Risk may be retained, so that the potential financial loss is completely the responsibility of the person exposed to risk. One may also reduce the risk by certain precautionary measures, such as by putting secure locks on the doors or installing a fire alarm system. In this way the magnitude of the probable loss can be limited. Finally, risk may be shared or transferred to another person or organization, and that is where we come to insurance.

The two main principles that form the foundation of insurance are risk transference and the law of large numbers.

Risk transference or "pooling" is what insurance is all about. Insurers take responsibility to cover the losses of their clients in exchange for regular payment that is called "premium". Premiums are considerably lower than the cost of the possible loss. Money from the clients forms a fund, which is used to reimburse expenses of the insured in case of robbery, fire, road accident, health emergency or any other reason listed in the insurance policy. This is how the risk is shared.

However, it would be obviously impossible for insurance company to refund all its clients at a time. One of the key goals for insurance companies is always to have a margin of assets over estimated liabilities in order to stay active in the industry and develop their business. And here the law of big numbers is used. Insurers look at the odds of event considered in the policy and thus estimate the probability of the need to cover the loss. This information comes from statistics such as mortality tables in case of life insurance or auto crash frequency for the car insurance. For more accurate calculations insurers use a theorem of probability theory - the law of big numbers: "The observed frequency of an event more nearly approaches the underlying probability of the population as the number of trials approaches infinity." In plain words, the more cars you insure, the more accurately you can predict the number of cars likely to be stolen.

Now with the basic knowledge of how the insurance industry operates you can make a weighted decision. Online insurance quotes are a powerful tool to find an insurance company in your area. You easily get information about several local providers, understand their offers and choose the policy most suitable for your needs and financial situation.