Insurance

Definition

Insurance is a way to manage your risk. Insurance is a contract between you (or a business) and an insurance company to help protect you and your loved ones from financial loss due to an unexpected event, like an accident, illness, natural disaster, or other unexpected circumstances. In the case of medical, dental or vision insurance, it can also help keep you or your family healthy by offsetting and sometimes covering the cost of routine care. When you buy insurance, you purchase protection against unexpected financial losses. The insurance company pays you or someone you choose if something bad happens to you.

If you have no insurance and an accident happens, you may be responsible for all related costs. Having the right insurance for the risks you may face can make a big difference in your life.

People get insurance not only to help with risks from unexpected events but also to help pay for routine things, such as annual medical checkups and dental visits. In addition, insurance companies negotiate discounts with health care providers, so their customers pay those discounted rates. An insurance policy is a written contract between the policyholder (the person or company that gets the policy) and the insurer (the insurance company). The policyholder is not necessarily the insured. An individual or company may get an insurance policy (making them the policyholder) that protects another person or entity (who is the insured). For example, when a company buys life insurance for an employee, the employee is the insured, and the company is the policyholder.

The insurance contract itself is called a policy. The policy outlines who or what will be covered under the contract, the circumstances for which payment will be issued by the insurance company, who will receive the payment, and how much they will receive.

An entity which provides insurance is known as an insurer, insurance company, insurance carrier, or underwritter. 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 (a premium) 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.

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.

From the standpoint of the insurer, an insurable risk must meet the following requirements:

1. The objects to be insured must be numerous enough and homogeneous enough to allow a reasonably close calculation of the probable frequency and severity of losses.

2. The insured objects must not be subject to simultaneous destruction. For example, if all the buildings insured by one insurer are in an area subject to flood, and a flood occurs, the loss to the insurance underwriter may be catastrophic.

3. The possible loss must be accidental in nature, and beyond the control of the insured. If the insured could cause the loss, the element of randomness and predictability would be destroyed.

4. There must be some way to determine whether a loss has occurred and how great that loss is. This is why insurance contracts specify very definitely what events must take place, what constitutes loss, and how it is to be measured.

From the viewpoint of the insured person, an insurable risk is one for which the probability of loss is not so high as to require excessive premiums. What is “excessive” depends on individual circumstances, including the insured’s attitude toward risk. At the same time, the potential loss must be severe enough to cause financial hardship if it is not insured against. Insurable risks include losses to property resulting from fire, explosion, windstorm, etc.; losses of life or health; and the legal liability arising out of use of automobiles, occupancy of buildings, employment, or manufacture. Uninsurable risks include losses resulting from price changes and competitive conditions in the market. Political risks such as war or currency debasement are usually not insurable by private parties but may be insurable by governmental institutions. Very often contracts can be drawn in such a way that an “uninsurable risk” can be turned into an “insurable” one through restrictions on losses, redefinitions of perils, or other methods.

How premiums are calculated

Insurers use risk data to calculate the likelihood of the event you are insuring against happening. This information is used to work out the cost of your premium. The more likely the event you are insuring against is to occur, the higher the risk to the insurer and, as a result, the higher the cost of your premium.

An insurer will take two important factors into account when working out the premium they will charge.

How likely is it in general terms that someone will need to make a claim?
Is the person who wants to take out a policy a bigger or smaller risk than the ‘average’ policyholder (for example, a young person with a high-powered car may be charged a higher premium as they are statistically more likely to be involved in an accident than a mature, experienced driver)?

Only a proportion of policyholders will make a claim in any one year.

Standard policy conditions

Although policies have different terms and conditions, in general there are three main principles that are common across all insurance policies. These include:

cover is provided for the actual value of the property or item that has been lost or damaged (its replacement value), but does not include any sentimental value
there needs to be a large number of similar risks so that the likelihood of a claim can be spread among other policyholders. It must be possible for insurers to calculate the chance of loss so that a premium can be set which matches the risk
losses must not be deliberate

How does insurance reduce your financial risk?

Imagine you’re driving your car and you hit a deer, which damages your car. If you have the right kind of auto insurance policy, the insurance company will pay the costs of the car repairs (minus the deductible the portion you have to pay). Now, imagine a water pipe bursts in your bathroom, ruining everything in that room and in the bedroom next to it. Typically, if you have homeowner’s or renter’s insurance, the insurance company will pay to replace some or all of the damaged property, once you pay your deductible. Insurance policies will only pay for things that are described in the policy. So it’s important to read a policy carefully before you buy it so you’ll know exactly what’s covered.

How do I choose an insurance provider?

Here are a few things to consider when choosing an insurance company to work with:

Insurance coverage
What types of insurance does the company offer? Can you buy all of your insurance through the company and receive a discount?
Financial strength
Would the company be able to pay your claim? Look to U.S. credit rating agency AM Best to determine the company’s financial strength.
Agency model
Would you prefer the help of a local insurance agent? Or would you prefer to manage your insurance on your own?
Customer service
Do others recommend this company? What are people saying about it in online customer reviews?

When in doubt, contact your local independent insurance agent and ask them any questions you have about insurance. Your agent is an insurance expert with the knowledge to guide you through the insurance process and help you find the best insurance protection for you and the people and things you care about most.

What are common types of insurance?

There are many types of insurance, but some common types are described here.

§ Health insurance: Helps you pay for doctor fees and sometimes prescription drugs. Once you buy health insurance coverage, you and your health insurer each agree to pay a part of your medical expenses usually a certain dollar amount or percentage of the expenses.

§ Life insurance: Pays a beneficiary you select a set amount of money if or when you die. The money from your life insurance policy can help your family pay bills and cover living expenses. There are different types of life insurance. One is term life insurance, which pays a benefit only if the insured person dies during the term of the policy (usually from one to 30 years). Another is whole life insurance, which pays a benefit whenever the insured person dies.

§ Disability insurance: Protects individuals and their families from financial hardship when illness or injury prevents them from earning a living. Many employers offer some form of disability coverage to employees, or you can buy an individual disability insurance policy.

§ Auto insurance: Protects you from paying the full cost for vehicle repairs and medical expenses due to a collision. In most states, the law requires you to have auto insurance when operating a motor vehicle.

§ Homeowner’s or renter’s insurance: Covers your home and the personal belongings inside in the event of loss or theft; helps pay for repairs and replacement. If you have a mortgage on your property, most lenders require you to have homeowner’s insurance. If you’re renting, the landlord might require you to have renter’s insurance

What should you consider when buying an insurance policy?

A useful rule to live by is to do your homework before you buy insurance. Research any insurance company you’re thinking about buying from to be sure that the company is financially sound and provides good service. Also find out what factors matter so that you can get the coverage you need at the best price.

Is Insurance an Asset?

Depending on the type of life insurance policy and how it is used, permanent or variable life insurance could be considered a financial asset because it can build cash value or be converted into cash. Simply put, most permanent life insurance policies have the ability to build cash value over time.

Insurance helps to protect you and your family against unexpected financial costs and resulting debts or the risk of losing your assets. Insurance helps protect you from expensive lawsuits, injuries and damages, death, and even total losses of your car or home.

Sometimes, your state or lender may require you to carry insurance. Although there are many insurance policy types, some of the most common are life, health, homeowners, and auto. The right type of insurance for you will depend on your goals and financial situation.

Insurance terms you need to know

Insurer: the insurance company providing the insurance policy
Policy holder: the person named on the policy
Policy limit: the maximum amount of money an insurance provider will pay out
Premium: the payment you make to the insurance company to keep your policy active
Deductible: the amount of money you’re responsible for paying out of pocket before insurance will pay out
Coinsurance: a percentage of costs you pay after meeting a deductible
Copay: a flat fee you pay each time insurance is used
Claim: a formal request for an insurance company to cover payments

Benefits of insurance

To summarize, here are some key benefits of having insurance:

Financial protection: Insurance helps protect you and your family against unforeseen events and losses that could result in high out-of-pocket expenses.

Risk mitigation: Insurance may reduce the financial burden of an unexpected expense.

Healthcare coverage: Health insurance helps cover the costs of a policyholder's medical expenses, including preventative care and treatments.

Legal assistance: Certain types of insurance, such as legal insurance or liability coverage, offer access to legal services, representation, and advice.

Tax benefits: Depending on the insurance policy, you may be eligible to deduct insurance premiums, leading to lower taxable income and potential tax savings.

Insurance, Definition, Types, Overview