The fundamental principle that all forms of insurance share is that spreading the cost of various risks across a large pool of people reduces the financial risk experienced by any single individual in the pool. Accordingly, because risks only occur to a fraction of the people in the pool, each person can be covered for the entire risk by paying just a fraction of the total cost for managing the risk. This is what insurance companies do as a business. They calculate the potential for different kinds of risks and what it will cost them to cover the costs of those risks if the worst happens. Then, they design a contract detailing what type of risk will be covered and at what amounts.
Insurance works well only when there are many people in the pool paying for coverage but few who actually make claims (requests for payment due to damage incurred as a result of a covered risk). This is called an economy of scale. When insurance companies are able to establish an economy of scale they are able to cover all claims made of them and still make a profit. When there are too many people filing claims relative to the total number of people in the pool, the insurance company loses money.
There are many types of insurance coverage available and each is designed to cover a specific type of risk. Because certain types of risk are applicable to everyone, almost everyone needs insurance to cover those types of risk. Additionally, because of a history rife with fraud and mismanagement, the insurance industry is regulated by the government.
Below is a discussion of the different types of insurance coverage the average person is likely to need.