Everything You Need To Know About Insurance, Explained!

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What Is Insurance?

Insurance is a contract, represented by a policy, in which an individual or entity receives financial protection or reimbursement against losses from an insurance company. The company pools clients' risks to make payments more affordable for the insured.

Insurance policies are used to hedge against the risk of financial losses, both big and small, that may result from damage to the insured or her property, or from liability for damage or injury caused to a third party.

Insurance is a way to manage your risk. 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.

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.

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 Does An Insurance Policy Work?

Insurance policies are often in place for a specific period of time. This can be referred to as the policy term. At the end of that term, you need to renew the policy or buy a new one. When you buy an insurance policy, part of your responsibility includes paying a fee called a premium. Some premiums are paid monthly, like health insurance. Others may be paid once or twice a year, like auto or homeowner’s insurance.

The cost of your premium generally depends on how much of a risk you are to the insurance company.

In addition to the premiums, most insurance policies include a deductible. That’s the amount you have to pay first, before the insurance company pays their share.

For example, if you have a $500 deductible on your homeowner’s policy and a storm causes $3,000 in damage, you will pay $500 and your insurance company will pay $2,500. With some policies, you can choose your deductible. Usually, a higher deductible means a lower insurance premium.

TIP

A good rule to live by is to

try to have an emergency

savings fund to cover the

cost of a deductible should

an accident occur.

What Are Common Types Of Insurance?

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

1. 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.

2. Life insurance: Pays a person 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.

3. 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.

4. 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.

5. Homeowner’s or renter’s insurance: Protects your home and personal property

against damage or loss and insure you in case someone gets hurt while on your

property. If you have a mortgage on your property, most lenders require you to

have homeowner’s insurance as a condition of the loan.

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.

Insurance Policy Components.

When choosing a policy, it is important to understand how insurance works.

A firm understanding of these concepts goes a long way in helping you choose the policy that best suits your needs. For instance, whole life insurance may or may not be the right type of life insurance for you. There are three components of any type of insurance (premium, policy limit, and deductible) that are crucial.

1. Premium

A policy's premium is its price, typically expressed as a monthly cost. The premium is determined by the insurer based on your or your business's risk profile, which may include creditworthiness.

For example, if you own several expensive automobiles and have a history of reckless driving, you will likely pay more for an auto policy than someone with a single mid-range 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.3

2. Policy Limit

The policy limit is the maximum amount an insurer will pay under a policy for a covered loss. 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 the insurer will pay is referred to as the face value, which is the amount paid to a beneficiary upon the death of the insured.

3. Deductible

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

Deductibles can apply per-policy or per-claim depending on the insurer and the type of policy. Policies with very high deductibles are typically less expensive because the high out-of-pocket expense generally results in fewer small claims.

4. Special Considerations

With regard to health insurance, people who have chronic health issues or need regular medical attention should look for policies with lower deductibles.

Though the annual premium is higher than a comparable policy with a higher deductible, less expensive access to medical care throughout the year may be worth the trade-off.