What Is Insurance?

Insurance is purchased to provide financial protection or reimbursement against losses resulting from accidents, injury, or property damage. An insurance company pools clients’ risks to make payments more affordable for the insured. Essential insurance policies that people tend to obtain are health insurance, auto insurance, business insurance, home insurance, and life insurance, to name a few.

Key Takeaways

The core components of most insurance policies are the premium, deductible, and policy limits.

Popular insurance policies include health, auto, business, home, and life insurance.

Insurance may cover costs associated with liability for damage or injury caused to a third party.

The National Association of Insurance Commissioners (NAIC) sets standards and regulations for insurance companies in the U.S.

Insurance

Some types on insurance (like auto or health insurance) may be mandatory.

Investopedia / Daniel Fishel

How Insurance Works

Many insurance policy types are available, and virtually any individual or business can find an insurance company willing to insure them, for a price. Common personal insurance policy types are auto, health, homeowners, and life insurance. Most individuals in the United States have at least one of these types of insurance, and car insurance is required by state law.

Businesses obtain insurance policies for field-specific risks. For example, a fast-food restaurant's policy may cover an employee's injuries from cooking with a deep fryer. Medical malpractice insurance covers injury- or death-related liability claims resulting from the health care provider's negligence or malpractice. A company may use an insurance broker of record to help it manage the policies of its employees. Businesses may be required by state law to buy specific insurance coverages.

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There are also insurance policies available for very specific needs. Such coverage includes business closures due to civil authority, kidnap, ransom, and extortion (K&R) insurance, identity theft insurance, and wedding liability and cancellation insurance.

Insurance Policy Components

Understanding how insurance works can help you choose a policy. For instance, comprehensive coverage may or may not be the right type of auto insurance for you. Three components of any insurance type are the premium, policy limit, and deductible.

Premium

A policy’s premium is its price, typically a monthly cost. Often, an insurer takes multiple factors into account through its underwriting process to set a premium. Here are a few examples:

Auto insurance premiums: Your history of property and auto claims, age and location, creditworthiness, and many other factors that may vary by state.

Home insurance premiums: The value of your home, personal belongings, location, claims history, and coverage amounts.

Health insurance premiums: Age, sex, location, health status, and coverage levels.

Life insurance premiums: Age, sex, tobacco use, health, and amount of coverage.

Much depends on the insurer's perception of your risk for a claim. For example, suppose you own several expensive automobiles and have a history of reckless driving. In that case, you will likely pay more for an auto policy than someone with a single midrange sedan and a perfect driving record. However, different insurers may charge different premiums for similar policies. So finding the price that is right for you requires some legwork.

Policy Limit

The policy limit is the maximum amount an insurer will pay for a covered loss under a policy. Maximums may be set per period (e.g., annual or policy term), per loss or injury, or over the life of the policy, also known as the lifetime maximum.

Typically, higher limits carry higher premiums. For a general life insurance policy, the maximum amount that the insurer will pay is referred to as the face value. This is the amount paid to your beneficiary upon your death.

The federal Affordable Care Act (ACA) prevents ACA-compliant plans from instituting a lifetime limit for essential healthcare benefits such as family planning, maternity services, and pediatric care.

Deductible

The deductible is a specific amount you pay out of pocket before the insurer pays a claim. Deductibles serve as deterrents to large volumes of small and insignificant claims.

For example, a $1,000 deductible means you pay the first $1,000 toward any claims. Suppose your car's damage totals $2,000. You pay the first $1,000, and your insurer pays the remaining $1,000.

Deductibles can apply per policy or claim, depending on the insurer and the type of policy. Health plans may have an individual deductible and a family deductible. Policies with high deductibles are typically less expensive because the high out-of-pocket expense generally results in fewer small claims.

Insurance is important because it helps protect you, your family, and your assets. It provides financial support and reduces uncertainties in business and human life. Insurance helps cover the costs of unexpected and routine medical bills or hospitalization, accident damage to your car or injury of others, and home damage or theft of your belongings. It can even provide your survivors with a lump-sum cash payment if you die. Insurance is a financial safety net that helps you recover after something bad happens.

WHY NEED INSURANCE ?

 

Why is Insurance Important?

The importance of insurance should never be undermined. Insurance acts as a vital shield against unforeseen circumstances. It protects you from unplanned expenses and offers a financial cushion from accidents, illnesses and more. Insurance safeguards the financial interests of your family in your absence. It helps them cover immediate expenses and secures their long-term financial stability.

Reasons Why Insurance is Important

Below are some reasons why insurance is important:

Provides Financial Stability

The need for insurance cannot be stressed enough. Insurance provides financial stability to families and helps them cover expenses like education, loans, housing, groceries and more. It also ensures financial stability during unexpected situations and helps cover medical expenses, property damage and other similar costs.

Promotes Personal Economic Growth

Insurance acts as a catalyst for personal economic growth by empowering surviving family members to pursue their aspirations in the absence of the policyholder. It provides a safety net to ensure your loved ones have access to essential resources, such as education. Your loved ones can also use the insurance payout to improve their financial situation by investing in businesses, purchasing real estate and more.

Generates Long-Term Wealth

Life insurance plans like endowment, money-back or Unit-Linked Insurance Plans (ULIPs) provide a means to accumulate wealth over time. These policies offer long-term savings and investment opportunities and allow you to secure your financial future. Life insurance can be used for various financial goals like retirement, a child's higher education and others.

Supports Families in Medical Emergencies

The importance of insurance is particularly pronounced in today's times. Medical expenses are skyrocketing due to medical inflation and the increasing frequency of various illnesses1. Therefore, having a robust health insurance policy is essential at this time. Health insurance offers financial protection against medical costs. It provides an affordable solution by allowing you to buy policies with a high sum assured without straining your wallet. It also guarantees access to quality healthcare services in your hour of need.

Key Reasons for Needing Insurance

Financial Protection: Insurance acts as a safety net, protecting you from substantial financial losses due to unforeseen events such as accidents, illnesses, or natural disasters. For instance, health insurance can cover high medical expenses, which are often a leading cause of bankruptcy. 

Risk Management: By pooling risks among a large group of people, insurance allows individuals to share the financial burden of unexpected events. This means that instead of facing potentially devastating costs alone, you can rely on your insurance provider to help cover those expenses. 

Peace of Mind: Knowing that you have insurance can provide peace of mind, allowing you to live your life without the constant worry of financial ruin from accidents or emergencies. This is particularly important for families, as life insurance can ensure that loved ones are financially secure in the event of an untimely death. 

Access to Services: Insurance often facilitates access to necessary services, such as healthcare. Individuals with health insurance are more likely to seek medical care when needed, leading to better health outcomes. 

Legal Requirements: In many cases, certain types of insurance are legally required. For example, auto insurance is mandatory in most states, ensuring that drivers can cover damages or injuries resulting from accidents. 

Protection of Assets: Insurance helps protect valuable assets, such as homes and vehicles, from damage or loss. Homeowners insurance, for example, can cover repairs from fire, theft, or natural disasters, safeguarding your investment. 

Insurance

Insurance is a means of protection from financial loss in which, in exchange for a fee, a party agrees to compensate another party in the event of a certain loss, damage, or injury. It is a form of risk management, primarily used to protect against the risk of a contingent or uncertain loss.

An entity which provides insurance is known as an insurer, insurance company, insurance carrier, or underwriter. A person or entity who buys insurance is known as a policyholder, while a person or entity covered under the policy is called an insured. The insurance transaction involves the policyholder assuming a guaranteed, known, and relatively small loss in the form of a payment to the insurer in exchange for the insurer's promise to compensate the insured in the event of a covered loss. The loss may or may not be financial, but it must be reducible to financial terms. Furthermore, it usually involves something in which the insured has an insurable interest established by ownership, possession, or pre-existing relationship.

The insured receives a contract, called the insurance policy, which details the conditions and circumstances under which the insurer will compensate the insured, or their designated beneficiary or assignee. The amount of money charged by the insurer to the policyholder for the coverage set forth in the insurance policy is called the premium. If the insured experiences a loss which is potentially covered by the insurance policy, the insured submits a claim to the insurer for processing by a claims adjuster. A mandatory out-of-pocket expense required by an insurance policy before an insurer will pay a claim is called a deductible (or if required by a health insurance policy, a copayment). The insurer may mitigate its own risk by taking out reinsurance, whereby another insurance company agrees to carry some of the risks, especially if the primary insurer deems the risk too large for it to carry.