What is the role of premiums in the insurance system?

In the insurance system, premiums serve a crucial role in spreading the risk of loss among all insured clients. When individuals pay premiums, they are contributing to a larger pool of funds. This collective fund is then used to cover the claims of those who experience a loss. The concept of spreading risk is fundamental to insurance; it allows multiple people to share the financial burden of risk. If an individual were to face significant losses—such as from an accident, damage to property, or health issues—the insurance product they invested in through their premiums enables them to receive financial support without incurring the full cost of their losses.

This mechanism creates stability and predictability for both the insurer and the insured. By pooling funds from many clients, insurers can manage the potential payouts more effectively and ensure that those who experience loss receive assistance while maintaining affordable costs for the whole group.