Insurance is a contract, represented by a policy, where the insured receives financial protection or compensation against losses from the insurance company. The company pools consumer risks to make payouts more affordable for the insured. Most people have some form of insurance: for their car, their home, their health care, or their life.
Insurance protects against financial losses resulting from accidents, injuries, or property damage. Insurance also helps cover costs associated with liability (legal responsibility) for damage or injury to a third party.
Insurance is a contract (policy) in which one insurer indemnifies another for losses caused by specific events or risks.
There are many types of insurance. Life, health, homeowners, and auto insurance are among the most common forms of insurance.
The basic components that make up most insurance policies are premiums, deductibles, and policy limits.
How does insurance work?
There are many types of insurance policies available, and virtually any person or business can find an insurance company willing to insure them—for a price. Common types of personal insurance are auto, health, home, and life insurance. Most people in the United States have at least one of these types of insurance, and state law requires auto insurance.
Businesses obtain insurance for field-specific risks. For example, a fast-food restaurant’s policy may cover employee injuries from cooking fried foods. Medical malpractice insurance covers liability claims related to injury or death resulting from a health care provider’s negligence or malpractice. A business may use an insurance broker to help manage its employee policies. State law may require businesses to purchase specific insurance coverage.
Components of an Insurance Policy
Understanding how insurance works can help you choose a policy. For example, comprehensive coverage may or may not be the right type of auto insurance for you. The three components of any type of insurance are the premium, the policy limit, and the deductible.
Premium
A policy’s premium is its price, usually a monthly cost. Often, the insurance company takes several factors into account when setting the premium.
Here are some examples:
Auto Insurance Premium: Your auto and property claims history, age and location, credit worthiness, and many other factors that can vary from state to state.
Home Insurance Premium: The value of your home, personal belongings, location, date of loss, and coverage amount.
Health Insurance Premium: Age, Sex, Location, Health Status, and Level of Coverage.
Life Insurance Premium: Age, Sex, Tobacco Use, Health, and Coverage Amount.
Much depends on the insurance company’s perception of your risk of injury. For example, let’s say you own several expensive cars and have a history of reckless driving. In this case, you’ll probably pay more for a car policy than someone with a midsize sedan and an excellent driving record. However, different insurance companies can charge different premiums for the same policies, so finding the right price for you takes some work.
Policy limits
A policy limit is the maximum amount an insurance company will pay for a loss under the policy. The maximum can be set per period (e.g. annually or per policy period), per loss or damage or over the life of the policy, also known as the lifetime maximum.
Higher limits usually mean higher premiums. In the case of general life insurance, the maximum amount that the insurance company will pay is called the face value. This is the amount paid to your beneficiary in the event of your death.
The federal Affordable Care Act (ACA) prevents ACA-compliant plans from imposing lifetime limits on essential health services, such as family planning, maternity benefits, and child care.
Deductible
A deductible is a certain amount you pay out of pocket before the insurance company pays the damage. Deductible acts as a deterrent to large amounts of small, insignificant claims.
For example, a $1,000 deductible means you pay the first $1,000 of any claim. Let’s say the damage to your car is $2000. You pay the first $1000 and your insurer pays the remaining $1000.
Deductible may apply per policy or per damage depending on the insurance company and policy type. Health schemes can have individual deductibles and family deductibles. Policies with higher deductibles are generally cheaper because higher deductibles usually result in smaller claims.
Insurance types
The National Association of Insurance Commissioners (NAIC) compiles an index of complaints about insurance companies. This information comes from state insurance agencies. The NAIC then compares the number of complaints to the insurer’s market share.
There are many different types of insurance. Let’s look at the most important ones.
Health insurance
Health insurance helps cover the costs of routine and emergency medical care, often with the option to cover vision and dental services separately. In addition to the annual deductible, you can also pay deductibles and co-insurance, which are your fixed payments or a percentage of medical benefits after meeting your deductible. However, many security services can be obtained for free before these limits are reached.
Health insurance can be purchased through an insurance company, an insurance agent, the federal health insurance marketplace, provided by an employer, or through federal Medicare and Medicaid coverage.
The federal government no longer requires Americans to have health insurance, but in some states, like California, you may pay a tax if you don’t have insurance.
Home insurance
Homeowners insurance (also called home insurance) protects your home, other property structures and personal belongings against natural disasters, unexpected loss, theft and vandalism. Homeowner’s insurance does not cover floods or earthquakes, which you must cover separately. Insurance providers often offer riders to increase coverage for certain properties or events and conditions that can help lower the deductible amount. These additions will result in an additional premium amount.
Renters insurance is another type of home owner insurance.
Your lender or landlord will likely require you to have home insurance coverage. For homes, if you don’t have coverage or have stopped paying your insurance bill, your mortgage lender can purchase and collect homeowner’s insurance.
Car insurance
Auto insurance can help pay for damages if you injure someone else or damage property in a car accident, help pay for accident-related repairs to your vehicle, or if your vehicle is damaged in a natural disaster.
Instead of paying out of pocket for car accidents and injuries, people pay an annual premium to an auto insurance company. The company then pays all or most of the costs associated with the car accident or other damage to the vehicle.
If you have a leased vehicle or borrowed money to buy a car, your lender or rental dealer will require you to have car insurance. Like homeowners insurance, your lender can purchase insurance for you if needed.
Life insurance
A life insurance policy guarantees that the insurance company will pay out to your beneficiaries (such as your spouse or children) if you die.
There are two major categories of life insurance policies. Term life insurance covers you for a specific period, such as 10 to 20 years. If you die during this period, your beneficiaries will receive the payout.
Travel Insurance
Travel insurance covers costs and losses associated with travel, including trip cancellation or delay, emergency medical care coverage, injuries and evacuations, damaged property, rental cars, and rental homes.
But even some of the best travel insurance companies don’t cover cancellations or delays due to weather, terrorism, or epidemics. They also don’t cover injuries caused by most extreme sports or adventure activities.
Why is insurance necessary?
Insurance helps protect you, your family, and your assets. An insurance company that covers the costs of unexpected and routine medical bills or hospitalizations, accidental damage to your car or injuries to others, damage to your home, or theft of your belongings will help you. If you die, the insurance policy can also give cash to your dependents. In short, insurance can provide protection against unexpected financial risks.
What is life insurance?
Depending on the type of life insurance and how it is used, permanent or variable life insurance can be considered a financial asset because it can increase in cash value or convert to cash. Simply put, most permanent life insurance policies have the ability to increase their cash value over time.
The Bottom Line
Insurance helps protect you and your family from unexpected financial expenses and the risk of losing loans or assets as a result. Insurance helps protect you from costly lawsuits, injuries and damages, death, and even the total loss of your car or home.
