Insurance companies will usually only insure against which type of risk?

Insurance is the pooling of money by a company from a group of people or organizations, to pay for the fortuitous losses that any of them may suffer. The money that the people pay to the insurance company is called the premium, and for this premium, the company promises to indemnify any of its customers for covered losses. The company may also provide risk management services.

Another way to look at it is that insurance involves the pooling of losses among its customers. In return for losing a little money in the form of a premium, the customers are indemnified against a large loss. Thus, the average loss among a group of people is substituted for actual losses.

To illustrate, consider a sample of 1,000 farms, and suppose that each farm were identical, and had the same value of $300,000 for the house and barn. Over the years, it was discovered that about 1 farmer would have a total loss every year. If a farmer's buildings burned completely, the farmer would be out of $300,000, but if each farmer paid into a fund every year to pay for the fires, then each would only have to pay 300,000/1,000 = $300 per year. Thus, for $300 per year, each farmer can avoid a loss of $300,000 if a fire destroys both house and barn. The Amish, a religious sect, do something similar, but instead of pooling money, they pool labor. If a farmer's barn burns down, for instance, then other members of the community pitch in and rebuild the barn. Thus, in exchange for providing some labor periodically, each farmer is protected against major losses.