How does insurance primarily function?

Insurance primarily functions by transferring the risk of loss from an individual or business to an insurance company. This means that when an insured party faces a potential financial loss—such as due to accidents, natural disasters, theft, or liability—they can mitigate the impact by paying premiums to the insurer. In return, the insurer agrees to cover specific types of losses as outlined in the policy. This mechanism allows individuals and businesses to have greater financial security and peace of mind, knowing that they have a safety net against unpredictable and potentially devastating financial events.

The essence of insurance lies in its role as a tool for risk management, where the pooling of risks among many policyholders enables the insurer to pay out claims while maintaining financial stability. Consequently, this model helps individuals and organizations avoid catastrophic losses that could otherwise lead to severe economic hardships.