How does insurance reduce your financial risk?

Because insurance compensates you for losses so your risk of losing everything is lower.

Insurance serves to ‘transfer’ the financial risk involved when a perilous event happens in the insured’s life. The insurance policy will assume the financial implications based on the policy specifics.

Here’s a simple scenario: You pay for health insurance in case something happens that creates thousands of dollars in medical bills. Had you not had the health insurance policy and something serious happens that results in huge medical bills, you would be responsible for those bills. However, by having heath insurance you’re effectively transferring that risk of financial loss to the insurance company, instead of assuming the entire financial risk yourself by ‘self-insuring’ in case of financial loss.

An insurance policy doesn’t stop Life from happening, but it helps transfer the financial risk associated w/ a covered peril to the insurance company.

Imagine you’re driving your car and you hit a deer, which damages your car. If you
have the right kind of auto insurance policy, the insurance company will pay the
costs of the car repairs (minus the deductible — the portion you have to pay).
Now, imagine a water pipe bursts in your bathroom, ruining everything in that
room and in the bedroom next to it. Typically, if you have homeowner’s or renter’s
insurance, the insurance company will pay to replace some or all of the damaged
property, once you pay your deductible. Insurance policies will only pay for things
that are described in the policy. So it’s important to read a policy carefully before
you buy it so you’ll know exactly what’s covered.

How Insurance Works

A multitude of different types of insurance policies is available, and virtually any individual or business can find an insurance company willing to insure them—for a price. The most common types of personal insurance policies are auto, health, homeowners, and life. Most individuals in the United States have at least one of these types of insurance, and car insurance is required by law.

Businesses require special types of insurance policies that insure against specific types of risks faced by a particular business. For example, a fast-food restaurant needs a policy that covers damage or injury that occurs as a result of cooking with a deep fryer. An auto dealer is not subject to this type of risk but does require coverage for damage or injury that could occur during test drives.

To select the best policy for you or your family, it is important to pay attention to the three critical components of most insurance policies: deductible, premium, and policy limit.
There are also insurance policies available for very specific needs, such as kidnap and ransom (K&R), medical malpractice, and professional liability insurance, also known as errors and omissions insurance.