what is insurance?
So, what exactly is insurance? At its core, insurance is a contract, represented by a policy, through which the policyholder receives financial protection or reimbursement against losses from an insurance company. This company pools risks from various clients, making payments more affordable for the insured individuals. Insurance is a common aspect of life, whether it’s for your car, home, health, or even your life.
Insurance policies cover financial losses stemming from accidents, injuries, or property damage. They also help cover costs related to liability, which is the legal responsibility for damages or injuries caused to a third party.
How Insurance Works
There’s a wide array of insurance policies available, and nearly anyone—individual or business—can find an insurance company willing to provide coverage, for a price. Common types of personal insurance policies include auto insurance, health insurance, home insurance, and life insurance. Most people in the United States have at least one of these types of insurance, and auto insurance is often required by state law.
Businesses secure insurance policies for specific risks within their field. For instance, a fast-food restaurant’s policy might cover employee injuries while cooking with a deep fryer. Medical malpractice insurance addresses liability claims related to injuries or death resulting from healthcare provider negligence or misconduct. State law might mandate specific insurance coverage for certain businesses.
There are also insurance policies tailored to very specific needs, such as kidnap, ransom, and extortion (K&R) insurance, identity theft insurance, and civil liability and wedding cancellation insurance.
Elements of an Insurance Policy
Understanding how insurance functions can guide your policy choices. For instance, full coverage might not necessarily be the right type of auto insurance for you. There are three key components to any insurance type: the premium, policy limit, and deductible.
Premium
The premium of a policy is its price, often paid on a monthly basis. Insurers consider numerous factors to set a premium. Here are a few examples:
- Auto insurance premiums: Your history of property and vehicle claims, age, location, creditworthiness, and other variables that can differ by state.
- Home insurance premiums: Your home’s value, personal belongings, location, claims history, and coverage amounts.
- Health insurance premiums: Age, gender, location, health status, and coverage levels.
- Life insurance premiums: Age, gender, tobacco use, health, and coverage amount.
Much depends on how the insurer perceives your claim risk. For instance, if you own expensive cars and have a history of reckless driving, you’re likely to pay more for auto insurance than someone with a mid-range sedan and a perfect driving record. However, different insurers may charge different premiums for similar policies. Thus, finding the right price requires some preliminary research.
Policy Limit
The policy limit is the maximum amount an insurer will pay for a loss covered by the policy. Limits can be set per period (e.g., annual or policy term), per loss or injury, or over the policy’s lifetime, also known as a lifetime maximum.
Higher limits usually come with higher premiums. For a general life insurance policy, the maximum amount the insurer will pay is called the face value. This is the amount paid to your beneficiary upon your death.
The federal Affordable Care Act (ACA) prohibits ACA-compliant plans from establishing a lifetime limit on essential healthcare benefits, such as family planning, maternity services, and pediatric care.
Deductible
The deductible is a specific amount you pay out of your pocket before the insurer pays a claim. Deductibles serve to discourage numerous small and insignificant claims.
For instance, a $1,000 deductible means you pay the first $1,000 of any claim. Suppose your car sustains damages totaling $2,000. You pay the initial $1,000, and your insurer covers the remaining $1,000.
Deductibles can apply per policy or per incident, depending on the insurer and policy type. Health plans might have an individual deductible and a family deductible. Policies with high deductibles are often less expensive because the higher out-of-pocket expense generally results in fewer minor claims.
Types of Insurance
Diverse Varieties of Insurance
A multitude of insurance options exists, each serving a unique purpose. Let’s delve into the most vital ones.
Health Insurance
Health insurance helps manage the costs of routine and emergency medical care, often with the option to add separate dental and vision services. Alongside an annual deductible, you might also encounter copayments and coinsurance—fixed payments or a percentage of a covered medical benefit after reaching the deductible. Many preventive services, however, might be covered for free before the deductible is met.
Health insurance can be obtained from an insurance company, an insurance agent, the federal Health Insurance Marketplace, through an employer, or via federal coverage such as Medicare and Medicaid.
Although the federal government no longer mandates Americans to have health insurance, some states, like California, may impose a tax penalty if you remain uninsured.
Home Insurance
Homeowner’s insurance (also known as home insurance) safeguards your home, other property structures, and personal belongings against natural disasters, unforeseen damages, theft, and vandalism. Renter’s insurance is a type of home insurance for renters.
Homeowner’s insurance won’t cover floods or earthquakes, which you’d need separate protection for.
It’s likely your lender or landlord will require you to have homeowner’s insurance coverage. In the case of homes, if you lack coverage or cease paying your insurance bill, your mortgage lender might obtain homeowner’s insurance on your behalf and charge you for it.
Auto Insurance
Auto insurance can assist in covering claims if you injure or damage someone else’s property in a car accident, help pay for accident-related repairs on your vehicle, or repair/replace your vehicle if stolen, totaled, or damaged due to a natural disaster.
Instead of paying out of pocket for accidents and auto-related damages, individuals pay annual premiums to an auto insurance company. The company then covers all or most of the costs associated with a car accident or other vehicle damage.
If you lease a vehicle or borrow money to purchase one, your lender or leasing dealer will likely require you to have auto insurance. Similar to homeowner’s insurance, the lender may purchase insurance on your behalf if needed.
Life Insurance
A life insurance policy ensures that the insurer pays a sum of money to your beneficiaries (such as your spouse or children) upon your death. In return, you pay premiums throughout your life.
Two main types of life insurance exist. Term life insurance covers you for a specific period, such as 10 to 20 years. If you pass away during that time, your beneficiaries receive a payout. Permanent life insurance covers you for your entire life as long as you continue paying premiums.
Travel Insurance
Travel insurance covers costs and losses related to travel, including trip cancellations or delays, emergency medical coverage, injuries and evacuations, and damage to luggage, rental cars, and rental homes.
Understanding Insurance: A Closer Look
So, what is insurance? Insurance is a method of managing financial risks. When you purchase insurance, you’re buying protection against unexpected financial losses. The insurance company pays you or someone you choose if something bad happens. If you don’t have insurance and an accident occurs, you could be responsible for all associated costs.
Why is insurance important?
Insurance helps safeguard you, your family, and your belongings. An insurer can help cover the costs of unexpected and routine medical bills or hospitalization, accident-related car damages or injuries to others, and damage to your home or theft of your belongings. An insurance policy can even provide your survivors with a lump-sum cash payment if you die. In essence, insurance can offer peace of mind concerning unforeseen financial risks.
Is insurance an asset? Depending on the type of life insurance policy and how it’s utilized, permanent or variable life insurance could be considered a financial asset because it can accumulate cash value or be converted into cash over time.
Bottom Line
In conclusion, insurance helps protect you and your family from unexpected financial costs and resulting debts, or the risk of losing your assets. Insurance shields you from costly lawsuits, injuries, damages, death, and even total losses of your car or home.
Sometimes, your state or lender might require you to have insurance. While many insurance types exist, some of the most common ones include life, health, homeowners, and auto insurance. The suitable insurance type for you will depend on your goals and financial situation.
