Financially it works like this: Pretend that you are part of a group of 100 people (A Risk Pool) each have a 1 percent chance of an accident that will cost 10000 dollars. So in an average year there will be 10,000 dollars worth of losses when one person gets in an accident. Without insurance, that one person will face a very painful financial burden, and everyone else will escape without any cost. If instead, everybody paid 110 dollars into an insurance fund at the beginning of the year there would be a cash pool available of 11,000. When the accident and loss happened, they could just pay the loss out of the account. Instead of a single person facing the brunt of the financial loss alone, it has been spread over a much broader community. Everybody is guaranteed to bear some cost, but nobody faces a devastating loss alone.

If the "Risk Pool" is made up of teenagers with a higher likelihood of accidents, then the insurer would need to charge more to build up a big enough insurance fund. If the Risk Pool was made up of slow driving, middle aged school teachers with inexpensive cars, then the insurer might be able to charge less and maintain a smaller insurance fund.

The insurance pool can also control its costs if it can minimize the number of claims that are presented to it. Common practices for minimizing claims include safety training, procedures and equipment (think safety belts and airbags), and agreeing that the consumer has to cover some of the costs himself (think deductible).

Insurance companies employ teams of actuaries whose job it is to figure out the statistical odds of a loss to determine just how much of an insurance fund will be necessary to cover the predicted costs and losses for the year.

Insurance doesn't eliminate the likelihood of loss or damage, it just provides a means of distributing those costs over a large group in a predictable way. As an insured I know that I face a "loss" of my insurance premium every year, whether I have an accident or not, but I also know that my cost for the year can never be greater than my premium payment plus my deductible.

How to find the right insurance provider.