Take a look at this illustration to see how premium and claims payments differ.
Imagine that you insure your $200,000 home for $500 per year. You have been making payments for ten years without making any claims.
That amounts to $500 divided by ten years. This indicates that your home insurance cost $5,000.
You begin to question why you are paying so much for absolutely nothing. In the eleventh year, your kitchen fire requires replacement. You receive $50,000 from the company to fix your kitchen.
When there was no claim, the insurance company would never have enough assets to pay out on claims if they gave everyone their money back.
Your $50,000 loss is not covered by the $5,000 you paid over ten years. A single loss renders you unprofitable for the business.
The company is able to build assets and pay for claims in the event of them because insurance is based on spreading the risk among a large number of people using the combined funds of all those paying for it.
