Insurance: Definition, How It Works, and Main Types of Policies

 What is insurance?

Insurance: Definition, How It Works, and Main Types of Policies

Most people have some type of insurance: for their car, home, motorcycle, and animals or even for their life. Yet most of us don't stop to think too much about what insurance is or how it works.

Simply put, insurance is a contract, represented by a policy, in which a policyholder receives financial protection or reimbursement for a loss from an insurance company. The company pools the risks of the customers to make the payout more affordable for the insured. 

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

• Key Takeaway Insurance is a contract (policy) in which one insurer indemnifies another for loss arising from specific contingencies or perils.
• There are many types of insurance policies. The most common forms of life, health, homeowner's and auto insurance.
• The main components that make up most insurance policies are the deductible, policy limit, and premium.

Insurance Works

There are a multitude of different types of insurance policies available, and virtually any individual or business can find an insurance company willing to insure them – for a price. The most common types of personal insurance policies are auto, health, home owners and life. Most individuals in the United States have at least one of these types of insurance, and car insurance is required by law.

Businesses require specific types of insurance policies that insure against specific types of risks faced by a particular business. For example, a fast-food restaurant needs a policy that covers damage or injury resulting from cooking with a deep fryer. An auto dealer is not subject to this type of risk, but does require coverage for damage or injury caused during a test drive.

  In order to select the best policy for you or your family, it is important to look at three important components of most insurance policies: the deductible, the premium, and the policy limit.

There are also insurance policies available for very specific needs, such as kidnapping and ransom (K&R), medical malpractice, and professional liability insurance, also known as errors and omissions insurance.

Insurance policy component

policy it is important to understand how insurance works.

A firm understanding of these concepts helps you choose the best policy to suit your needs. For example, whole life insurance may or may not be the right type of life insurance for you. Three components of any type of insurance are important: the premium, the policy limit, and the deductible.

• Premium

for a policy is its price, usually expressed as a monthly cost. The premium is determined by the insurer based on the risk profile of you or your business, which may include creditworthiness.

For example, if you own several expensive automobiles and have a history of reckless driving, you will pay more for an auto policy than someone with a midrange sedan and a perfect driving record. However, different insurers may charge different premiums for the same policies. So finding the right price for you requires some legwork.

• Policy Limit

Policy limit is the maximum amount an insurer will pay under the policy for a covered loss. The maximum can be set per period (for example, annual or policy term), per loss or injury, or during the life of the policy, also known as a lifetime maximum.

Generally, higher limits carry higher premiums. For a normal life insurance policy, the maximum amount payable by the insurer is referred to as the face value, which is the amount paid to the beneficiary upon the death of the insured.

deductible is a specific amount that the policyholder must pay out of pocket before the insurer will pay a claim. Deductibles serve as a deterrent to large amounts of small and insignificant claims.

Deductibles may apply per policy or per claim, depending on the insurer and the type of policy. Policies with very high deductibles are generally less expensive because higher out-of-pocket expenses generally result in fewer small claims.

Insurance

There are many different types of insurance. Let's look at the most important.

Health Insurance

With regard to health insurance, people who have chronic health problems or need regular medical attention should look for policies with low deductibles. Although 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 tradeoff.

Homeowners insurance (also known as home insurance) protects your home and property against damage or theftVirtually all mortgage companies require borrowers to have insurance coverage for the full or fair value (usually the purchase price) of a property and will not loan or finance a residential real estate transaction without proof of this.