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The Basics of Insurance Stocks

By Motley Fool Staff - Apr 7, 2016 at 11:27AM

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Here’s the layman explanation for how the insurance industry works.

Insurance can be a fantastic place to invest. But what do insurance companies actually do, and what kinds of insurance companies are there?

Join The Motley Fool's Gaby Lapera and Jordan Wathen as they discuss the very basics of insurance, from car to homeowners insurance to reinsurance -- the business of insuring other insurers.

A transcript follows the video.

This podcast was recorded on April 4, 2016. 

Gaby Lapera: Everyone has insurance, or you ought to have insurance, especially if you have a car or are alive, you ought to have insurance. Do you know how insurance companies work? Do you know how to invest in insurance companies? This is what we're going to try and cover today. Starting at the most basic unit of matter, as one would say in chemistry, what do insurance companies do, Jordan?

Jordan Wathen: The best way I've ever heard insurance companies explained is you can think of them like a group saving's account where the money that you can take out isn't based on much you put in, but how much you need, because you've been unlucky in one way or another.

Lapera: That is a really good explanation actually.

Wathen: Yeah, I borrowed that from a book and we'll talk about that later. The way to think about it is money is pooled together from a bunch of people who all have risk of one type or another, health or life or car insurance. As people need it for calamities, they can send a claim into their insurer and the insurer will write them a check for it to cover their losses.

Lapera: Right, and as you covered while you were talking, there's all different types of insurance. There's life insurance, which I think people know about. You die, you kick the bucket, and the company pays out and it helps cover funeral expense or end of life expense or whatever it is, provide a little bit of a living for whatever survivors you leave behind. There's health insurance, which I think everyone is familiar with in the United States of America anyway. Auto insurance, which you should definitely have if you drive a car. There's all sorts of things, but I think what a lot of people don't realize, is that there's a lot of different other types of insurance companies that the average person isn't really going to deal with. The one that springs to mind immediately is reinsurers.

Wathen: Right, reinsurers are a special kind of category, because they actually insure insurance companies. When an insurance company doesn't want to take on the full loss of the premiums they've written, they can pass it on to a reinsurer and mitigate some of their losses should say an extreme even occur, a big loss like a catastrophe or a hurricane, something of that sort.

Lapera: Absolutely.

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