Insurance is protection from losing or damaging something.
It is defined as the transfer of loss risk in exchange for payment.
Basically, if we damage or lose something that was insured, the insurance will cover the cost of having it fixed or replaced.
There are two parties in an insurance transaction:
- Insurers: Insurance companies who take on the risk and provide coverage
- Insured: People who buy the insurance and make the periodic payments for the coverage
How does Insurance Work?
When a person or business signs up for insurance with an insurance company, they get a contract called the insurance policy.
This insurance policy outlines
- What the insured needs to pay the insurer periodically
- And what the insurer promise to pay the insured if and when the risk of loss becomes a reality.
Insurance is based primarily on two things:
- Premiums: The amount of money the insured keeps paying the insurer to cover their risk of loss
- Claims: The amount the insurer pays the insured incase the risk of loss becomes a reality.
The business model of insurance companies is to calculate risk in such a way that the Premiums received are always greater than the Claims paid out.
The higher the risk of loss becomes a reality, the higher the premiums. If the risk of loss is too high, the insurance company will not even provide the insurance.
Types of Insurance
There are many different types of insurance in the market. A few of the main ones are:
- Auto Insurance
- Home Insurance
- Health Insurance
- Life and Disability Insurance
- Critical Life Insurance
- Funeral Insurance
- Property Insurance
- Mortgage Insurance
- Liability Insurance
Check out the calculators on each to see what you could be eligible for.
Advantages of Insurance
Depending on the type of insurance:
- You mitigate away the risk of a big loss
- Builds the habit of saving for a rainy day
- You do not have to worry in the case of sickness or accident
- Your family is taken care of in case you are no longer around
- Contributes to the idea of Financial Freedom and peace of mind
- You can stop the insurance coverage any time you want
Disadvantages of Insurance
Again, depending on the type of insurance:
- You have to keep paying premiums periodically
- If the risk of loss never materializes, your premiums are all for naught
- The insurance company (insurer) will try to find any technicality not to pay the claims
- If the risk is too high, you might not get insurance coverage when you most need it
Insurance is an effective financial tool used to protect oneself from the risk of losing something valuable.
In this day and time, you can potentially insure anything that has the risk of loss attached to it, but like any financial transaction, one has to read the fine print to ensure the claims are paid out in case of an actual loss.