An insurance program should be a part of every family's total financial plan. Before you can evaluate various insurance programs, you must understand the reasons for buying insurance and how to determine the amount and kind of insurance you need. Insurance is one way of protecting yourself against the risk of unexpected financial losses. It does not remove the risk, but it can partially compensate for losses incurred. Through the payment of premiums, you transfer the cost of a major loss from you to an insurance company.
Insurance operates on the principle of shared risk.
A group of people pay in specified premiums to a common pool. Funds from the pool are used to cover individual losses. The amount of premium each individual pays is based on the frequency of past losses by the group, plus the costs of administration and selling, divided by the number in the group. Analyze the financial impact of the risk on your particular situation. Determine how you should handle the risk.