Say you are the proud owner of a car – a Probox – which costs Kshs.1 Million. If you were to be involved in a traffic accident and the car is written off, you would have to raise Kshs.1 Million to replace it. But say there are 10,000 such Proboxes in the country whose total value is Kshs.10 Billion. Of these, an average of 1000 Proboxes have been involved in accidents annually for the past five years. The resultant losses have been Kshs.1 Billion per annum. If this cost of Kshs.1 Billion was to be shared equally by the owners of the 10,000 cars, each would bear a cost of Kshs.100,000/=.
Insurance works on this simple logic. Instead of each person having to face the demon of his or her loss alone, s/he contributes to a pool on the understanding that if misfortune does strike, the pool will be at hand to assist the person in getting back what has been lost. Since a large number of people contribute to the pool, there is enough money to compensate those who have suffered losses as well as to administer the fund and for the insurance company to take something home by way of profit. The larger the number contributing to the pool and the lower the number of losses, the lower the premiums. The converse also holds true.
It’s quite simple really. Elegant too. No voodoo involved. Just logic and common sense.