How do insurance companies manage to pay for an individual's catastrophic loss?

Insurance companies manage to pay for an individual's catastrophic loss by implementing a system of risk pooling. This means they collect premiums from a large number of policyholders, thereby creating a collective pool of funds. The idea behind this strategy is that while only a small fraction of policyholders will experience catastrophic losses, the premiums collected from all policyholders provide the financial resources necessary to cover these claims.

This method allows insurance companies to distribute the financial risk associated with insuring individuals across a broader base, ensuring that they have adequate funds when a significant claim arises. In contrast, raising premiums for all policyholders might not equate to an actual solution for funding specific catastrophic claims. Additionally, relying on government funds could be inconsistent and uncertain. Selling claims to third-party investors could complicate the process without guaranteeing adequate or timely funding for those affected. Therefore, collecting premiums from all policyholders is the foundational strategy insurance companies use to provide coverage for catastrophic losses.