If You Don't Understand Insurance, You Don't Understand Money
How insurance companies actually make money (and why it matters).
You think you’re smart with money. You’re saving. You’re investing. You’re planning.
But do you really understand insurance?
If the answer is “kinda,” you don’t actually understand money. Period.
People hate insurance. They think it’s a scam. A waste of cash.
“I’m just giving my money away for nothing.”
They’re wrong.
It’s the one thing that stops you from going back to zero.
One car crash, one house fire, one lawsuit, and your entire net worth can disappear. Poof.
This isn’t about getting rich. This is about staying rich.
Let’s break it down.
What is insurance?
Insurance is just a transfer of risk.
Imagine you have a $1,000 phone. You’re worried you’ll shatter it.
Your friend Sarah says, “Give me $100. If you shatter your phone this year, I’ll buy you a brand new one. No questions asked.”
You make the deal.
Why? Because you’d rather pay a small, certain cost ($100) than risk a large, unexpected one ($1,000).
You just transferred your risk to Sarah. That’s it. That’s all insurance is. You’re paying to make a big, scary problem someone else’s problem.
The law of large numbers
So how does Sarah (the insurer) not go broke?
She’s not dumb. She doesn’t just make the deal with you. She makes that same $100 deal with 100 other people.
Now Sarah has $10,000 in cash.
She knows that most people are careful. She bets that only five of those 100 people will actually break their phone.
She’s right. Five people break their phones. She pays out $5,000 ($1,000 x 5).
What’s left? She has $5,000 in pure profit.
The money from the many (the 95 who didn’t break their phone) pays for the losses of the few (the 5 who did).
Sarah just built a business by managing risk.
Why is insurance so risky?
Sounds easy, right? Sarah just collects cash and pays out less?
Wrong.
Sarah’s business model has two giant, hidden problems.
Problem #1: Bad luck
The second Sarah offers her $100 phone insurance, who’s the first person to run to her?
Is it the super-careful person who keeps their phone in a case?
No.
It’s the guy who’s already broken three phones this year. It’s the person who uses their phone as a hockey puck.
The people who need insurance the most are the ones who are most likely to use it.
That’s “adverse selection.” The insurer’s “pool” doesn’t stay average. It gets filled with high-risk people.
If Sarah’s pool of 100 people is actually 50 chronic phone-breakers, her math blows up. She’ll go broke.
This is why insurers can’t just take your money.
They have to ask you 100 annoying questions first. “What’s your age?” “Where do you live?” “What’s your driving record?”
They’re not being nosy. They’re underwriting.
They’re trying to figure out if you’re the careful person or the hockey-puck guy so they can charge you the right price.
Problem #2: Carelessness
Okay, let’s say Sarah gets a good pool of customers. She insures you. You’re a careful person.
...But now you have insurance.
Suddenly, you’re not so careful. You start tossing your phone on the counter. You use it in the rain. Why not? If it breaks, Sarah buys you a new one.
That’s “moral hazard.” People change their behavior because they’re protected from the consequences.
If everyone with insurance suddenly stops caring, Sarah’s “5 out of 100” guess turns into “20 out of 100.” Again, she goes broke.
This is the entire reason deductibles exist.
When Sarah says, “I’ll buy you a new $1,000 phone, but you have to pay the first $150,” what happens?
You suddenly start being careful again. You don’t want to pay that $150.
The deductible forces you to keep “skin in the game.” It makes sure you still care.
How insurance companies really make money
So, you think Sarah’s $5,000 profit (her “underwriting profit”) is how she gets rich.
That’s cute. But it’s not the real game.
The real secret is something so powerful, Warren Buffett used it to build a multi-billion dollar empire.
It’s called “the float.”
Think about it. Sarah collected $10,000 from her 100 customers. When does she collect it?
Day 1.
When does she pay out the $5,000 in claims?
Later. Maybe months. Maybe a year. Maybe never.
So what does Sarah have in the meantime? She’s sitting on a $10,000 pile of cash.
Cash that isn’t hers.
This giant pool of money (all the premiums collected that haven’t been paid out in claims yet) is the float.
What does Sarah do with this $10,000? Does she let it sit in a checking account?
Hell no.
She invests it. She buys stocks. She buys bonds. She buys real estate.
She uses that $10,000 to go out and make more money.
This is the real business model.
The float is a giant, interest-free loan from you to the insurance company.
In fact, an insurer can lose money on underwriting (pay out $11,000 in claims after collecting $10,000) and still get filthy rich, as long as the profit they made from investing the float is bigger than their $1,000 loss.
They get paid to hold your money, then they get paid again from investing it.
That is the magic of insurance.
The art of saying “no”
So, if the game is to get the float, the logical step is to sell as many policies as possible, right? Get more cash in the door.
This is the trap. And it’s where “stupidity,” as Buffett calls it, destroys most insurance companies.
What’s the easiest way to get more customers?
Lower your price.
So, a new, “stupid” insurer (let’s call him Jerry) shows up. Jerry wants that float. He offers the same $1,000 phone insurance for just $50.
He gets 1,000 customers overnight. He’s sitting on a $50,000 float. He feels like a genius.
But he’s a dead man walking.
He just attracted every high-risk, phone-breaking person in the city.
And he’s not charging nearly enough to cover the claims that are about to pour in.
When the claims come, Jerry’s $50,000 float vaporizes. He’s bankrupt.
The smart insurer (Sarah) has discipline. She knows her math. She knows $100 is the right price for the risk.
She is willing to say “NO” to bad business. She is willing to sell fewer policies if the price isn’t right.
The art of insurance isn’t just about managing risk. It’s about managing greed.
The best companies are masters at walking away from a bad deal, even when the cash looks tempting.
Why we need insurance
Let’s zoom out.
This might sound crazy, but insurance is the reason our world looks the way it does.
Without it, the world we know would grind to a halt.
Think about it:
You couldn’t buy a house. No bank would ever lend you hundreds of thousands of dollars for a home if a single fire could instantly make their investment disappear. They require you to have insurance before they’ll even talk to you.
The products you buy wouldn’t exist. The car you drive and the phone in your pocket were built in massive factories. Those factories only exist because an insurance policy protects them from being wiped out by a single disaster. The jobs at those factories wouldn’t exist, either.
The small businesses you love couldn’t open. The local coffee shop or the restaurant down the street could never afford to open their doors if one slip-and-fall lawsuit could take away the owner’s entire life savings.
Insurance is like a giant safety net that protects our entire economy.
It gives everyone the confidence to take risks.
It’s the reason banks can lend, builders can build, and entrepreneurs can create the jobs and services we all rely on every day.
Why this all matters
So, why should you care about any of this?
Because you’re working hard for the life you have. Your home, your car, your savings, your family’s future.
All of it can be gone in a single bad day.
Stop thinking of insurance as a “bill” or a “waste of money.” It’s not.
It’s the one thing that stops you from going back to zero.
It’s the safety net that lets you sleep at night, knowing that one piece of bad luck (like one diagnosis or one accident) won’t destroy everything you’ve built.
Each policy is a solution to the problem of “what if”:
Health insurance: You get a terrible diagnosis. This is what stops you from having to choose between the best medical care and going bankrupt with $500,000 in bills.
Home/renters insurance: A fire rips through your home. Your stuff is gone. This is the difference between standing on the sidewalk with nothing... and getting a check to rebuild your life.
Auto insurance: You glance at your phone for one second and cause a horrible accident. This is what stops you from having your paycheck taken for the rest of your life to pay for someone else’s car, medical bills, and lawsuits.
Disability insurance: This is the one almost everyone forgets. Your ability to get up and go to work is your most valuable asset. If you get hurt and can’t work for a year, this pays your bills. It protects your paycheck when you can’t.
Life insurance: This one isn’t for you. It’s for the people you love. It’s the money that pays off the mortgage and keeps your family’s life on track if you’re suddenly not there.
It’s a simple trade. You’re paying a small, predictable amount to get rid of a huge, unpredictable financial disaster.
It’s the smartest deal you’ll ever make.
What to do next
You now know more about insurance than 99% of people. So what?
Knowledge is useless without action. It’s just potential. You have to do something with it.
Here’s your plan. Do it this weekend. Not “later.” Now.
Download and print your policies. All of them. Home/renters, auto, health, life, disability. Lay them out on your kitchen table. If you can’t find them, log in and download the “Declarations Page” for each one. This is the 1-page summary.
Find your “deductible.” Look at each policy. Find the dollar amount you have to pay before the insurance company pays a dime. Ask yourself one question: “If a disaster happened tonight, do I have this amount in cash, ready to go?” If the answer is no, you have a massive, stupid hole in your plan. Fix it.
Find your “liability limit.” This is the big one. Look at your auto and home insurance. Find the maximum amount they will pay if you get sued. Is it $100,000? $300,000? Now, look at your net worth. If your liability limit is lower than your net worth, you are an idiot. You are literally risking everything to save a few bucks a month. Call your agent and get an umbrella policy. It’s cheap, and it stops you from losing it all.
Check your “life” and “disability” policies. If you have people who depend on your income, you need life insurance. Period. If you depend on your income, you need disability insurance. This isn’t a “nice to have.” It’s the “don’t go broke and lose your house” plan.
Stop “thinking about it.” Stop “shopping around.”
Fix it. Today.
It’s your move.