Insurance is a contract that transfers risk from one party to another. The policyholder pays a premium. In return, the insurer agrees to cover specified losses. The idea is pooling. Many people pay premiums, but only some suffer losses. The premiums of the many cover the claims of the few. It is one of the oldest financial inventions, with roots in Babylonian merchants and Lloyd's coffee house in 17th-century London.

Policies cover many risks. Auto insurance pays for collision damage and liability. Homeowners insurance covers fire, theft, and storms. Health insurance pays medical bills. Life insurance pays beneficiaries when the insured dies. Business insurance covers liability, property, and interruption. Each policy has limits, deductibles, exclusions, and conditions. The details determine what is actually covered.

Insurers make money in two ways. They earn underwriting profit when premiums exceed claims and expenses. They also earn investment income by investing premiums until claims are paid. A bad year of catastrophes can wipe out underwriting profit, which is why insurers buy reinsurance to spread extreme risks.

Insurance markets can fail. When insurers cannot assess risk accurately, they either charge too much and lose customers or charge too little and go bankrupt. Climate change is straining the system, with insurers withdrawing from wildfire and flood zones. Insurance only works when risk is measurable and spread widely enough.