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### Course: Financial Literacy>Unit 6

Lesson 2: Insurance basics and terminology

# How insurance works

Insurance is a way to protect yourself from financial risks by paying a company a small amount of money, called a premium. If something bad happens, like a car accident or a house fire, the insurance company helps cover the costs so you don't have to pay for everything yourself. Created by Sal Khan.

## Want to join the conversation?

• Sal sys "........So for example, if across millions of people, all of them are paying \$200 and there's a 1% chance of having to pay out \$10,000, well that means on average 1% of \$10,000 is \$100, on average, they're gonna be paying out about \$100 per insured person who's just like that...."

I did get how insurance companies make money but how and why did sal say 1% of 10000\$?? I don't understand how to interpret this.
• Hi Lakshman666,

Sal is using a concept called "expected value" in statistics:

Let's break it down a bit more.

Imagine you have 100 toy cars. Each toy car represents a person who has insurance. Now, the insurance company thinks that out of these 100 toy cars, only 1 (that's the 1% chance) will have an accident.

If that accident happens, the insurance company will need to pay \$10,000. But remember, this only happens to 1 toy car out of 100 (since the chance is only 1%).

So, if we spread that \$10,000 cost across all 100 toy cars, it's like each toy car is carrying a tiny piece of that cost.

When you do the math ([0.01 * 10000]), it turns out each toy car is carrying \$100 of that cost.

That's why Sal says the insurance company is expecting to pay out \$100 per person. It's like each person is carrying a tiny piece of the risk.

Does that make sense?
• Does the amount you must pay for your insurance depend on your records? For example, in the car insurance example mentioned in the video, would they give a higher rate to someone who crashed their car twice in the last five years than to someone who has never crashed their vehicle in their five years of driving? If yes, for which insurance do they check your records? What information would they check for?

P.S. I'm sorry if this question is long. I just wanted to be specific.
• Yes, you will pay a higher premium if you have a reportable accident on your driving record. Also most moving violations. Your record is kept by the state issuing your driver's license and is available to insurance companies. And you will be asked when filling out an application if you have had any accidents within a certain amount of time. Don't lie. Usually the penalty rate is only in effect for a certain amount of time (a few years).
• I strongly disagree with some of these 'correct' answers. Why can't we ask questions after answering each question? I can't remember the questions or the answers and don't see any way to go back.
(1 vote)
• Who would respond to your questions? Just other ignorant folks like the other learners on the course. There are no teachers here.
(1 vote)
• What is insurance?