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financial, the insurance payment may compensate, to some degree, for pain and suffering. If
no loss event occurs, the insurer pays you nothing and in hindsight it might seem that you
paid an insurance premium for nothing. Of course, you did get something for your money—
protection against a bad outcome that allowed you to sleep better at night. If you bought
fire insurance on your house and it did not burn down, you probably don't regret paying that
insurance premium.
The amount and variety of insurance policies that can be purchased is staggering. Life
insurance, car insurance, health insurance, flood insurance, liability insurance—the list goes
on and on. Huge amounts of risk are transferred from those who don't want it to those who
think they can manage it at a profit.
Despite this abundance of insurance, many risks remain uninsured. We all know from
personal experience that insurance rarely covers all losses that we are worried about.
Sometimes we know this before we buy a policy and sometimes we find out later when we
try to collect. Just as there are few perfect hedges, there are few perfect insurance policies.
In order to write an insurance policy, insurers must convince themselves that the risk is
identifiable, quantifiable, manageable, and saleable at a profit. Running an insurance company
is largely an exercise in risk management and in marketing.
Why can an insurance company handle risks that everyone else wants to get rid of?
Because, above all else, an insurance company can diversify away much of the risk. By
pooling hundreds, thousands, or