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How Insurance Works: Explaining 3 Key Insurance Concepts

At Owen Insurance Agency, we endeavor to explain the “whys” and “hows” of the insurance industry so that you have all the information that you need to make informed decisions. In this blog post, I will explain 3 key insurance concepts:

an insurance policy, with some money

  1. How any type of insurance works, fundamentally.

  2. The individual components of an insurance policy.

  3. The claims process, from when a loss occurs to when a claim is approved or denied.

How Insurance Works

The National Association of Insurance Commissioners (NAIC) describes insurance as the pooling and sharing of risks that are fundamental principles that help stabilize the financial impact of unexpected events for individuals and businesses(1). But what does that mean?

In its simplest form, insurance is a risk management strategy that involves the transfer of risk from an individual or entity to an insurance company in exchange for a premium. The insured pays a regular premium and in return, the insurance company commits to providing financial protection or reimbursement in the event of a covered loss. 

In technical terms, this process is based on the principles of risk pooling and risk sharing, which I will explain below:

What is Risk Pooling?

Insurance companies collect premiums from a large pool of policyholders who face similar risks. By aggregating, or joining together, these premiums, insurers create a financial reserve to cover the potential losses experienced by any individual within the group.

sharing on a typewriter

What is Risk Sharing?

The idea of risk sharing goes hand in hand with risk pooling. If a pool of policyholders is large and diverse enough, then it is highly unlikely that every policyholder will experience a loss simultaneously. When a covered loss occurs for an individual, the financial burden is shared collectively by the entire pool through the premiums that the individual policy owners pay.  

The Individual Components of any Insurance Policy

The Policyholder:

The individual or entity that purchases an insurance policy. The policyholder pays premiums to the insurance company in exchange for coverage.

The Premium:

The premium is the amount of money paid by the policyholder to the insurance company at regularly defined intervals (monthly, quarterly, or annually). This payment is essential for maintaining coverage, and it is routinely adjusted as an insurance company examines the size (and risks) of their pool of policyholders.

The Coverage Limits:

Every insurance policy has limits on the amount of coverage provided. These limits specify the maximum amount that an insurance company will pay in the event of a covered loss. Policyholders should choose coverage limits that align with their specific needs and risk tolerance. That can seem like a daunting task, but at Owen Insurance Agency we are always ready to help you!

The Deductible:

The deductible is the amount the policyholder must pay out of pocket before the insurance company will cover the remaining costs. As a general rule, choosing a policy with a higher deductible often results in lower premium costs, but in the event that a claim is filed a policyholder must pay more money before an insurance company will step in and cover the remaining costs.

In their publication, "How Insurance Works," the Insurance Information Institute (III) emphasizes the importance of comprehending policy components such as premiums, coverage limits, and deductibles to make informed decisions when selecting insurance coverage(2). This information allows policyholders to customize their coverage based on individual needs and financial considerations. 

The Claims Process

The true test of any insurance policy comes when a covered loss (a loss that is covered under the terms of your insurance policy) occurs, and the policyholder needs to file a claim. The claim process, where a loss is identified as covered or not, involves several steps:

an auto accident

1. A Loss Occurs

The policyholder experiences a loss or damage that is covered by the insurance policy. Depending on the insurance policy you have, this loss/damage could be a car accident, a medical emergency, property damage, or any other event specified in the policy.

2. The Insured Notifies the Insurer: The Birth of a Claim

The policyholder must promptly notify the insurance company about the incident (i.e., file a claim). Timely notification is crucial to the claims process; if too much time passes between the loss or damage and when an insurance company is notified, it can result in the claim being denied.

3. The Claim is Investigated

The insurance company will conduct an investigation to verify the validity of the claim. This process could include such steps as gathering information over the phone, interviewing the involved parties, having an expert assess the extent of the loss, obtaining files, or other means of investigation.

4. The Claim is Either Approved or Denied

If a claim is approved, then the insurance company will determine the amount of compensation based on the policy terms, coverage limits, and deductibles.

If the claim is denied, then a notice of the denial and a reason for the denial will be sent to the policyholder. 

5. Payment

several one dollar bills

Assuming the claim is approved, the insurance company will issue a payment to the policyholder to cover the approved claim amount. 


Insurance operates on the principles of risk pooling and risk sharing, which allows individuals and businesses to mitigate the financial impact of unexpected events. In this blog we discussed the individual components of an insurance policy such as premiums, coverage limits, and deductibles. We also covered a general overview of the claim process, which is a critical aspect of insurance that ensures that policyholders receive the financial support they need when faced with covered losses.

I know that all of this can seem very complicated but remember that you are not alone. At Owen Insurance Agency, myself or anyone on my team is ready and willing to discuss your specific insurance needs. Reach out today and let us help!


  1. National Association of Insurance Commissioners (NAIC). (2022). Understanding Insurance. Retrieved from [NAIC Understanding Insurance] (

  2. Insurance Information Institute (III). (2022). How Insurance Works. Retrieved from [III How Insurance Works](

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