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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. In order to select the best policy for you or your family, it is important to pay attention to the three critical components of most insurance policies—the deductible, premium, and policy limit There are also insurance policies available for very specific needs, such as kidnap and ransom (K&R), medical malpractice, and professional liability insurance, also known as errors and omissions insurance. When choosing a policy, it is important to understand how insurance works. There is 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 core components that make up most insurance policies are the deductible, policy limit, and premium. 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.
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.
How Insurance Works
There is 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, homeowners, 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 special 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 that occurs as a result of cooking with a deep fryer. An auto dealer is not subject to this type of risk but does require coverage for damage or injury that could occur during test drives.
In order to select the best policy for you or your family, it is important to pay attention to the three critical components of most insurance policies — the deductible, premium, and policy limit
There are also insurance policies available for very specific needs, such as kidnap and ransom (K&R), medical malpractice, and professional liability insurance, also known as errors and omissions insurance.
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.
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.
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.
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.
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.
Terms in Insurance
Alliance of American Insurers (AAI)
The Alliance of American Insurers is a coalition consisting primarily of property-casualty insurance carriers. read more
Associate in Information Technology (AIT)
The Associate in Information Technology (AIT) designation is geared toward educating insurance professionals about the IT environment. read more
"Accelerated benefits" refers to a clause in certain life insurance policies that enables the policyholder to receive the benefits before death. read more
Accident Year Experience
Accident year experience is used to show premiums earned and losses incurred during a specific period of time. read more
Accident and Health Benefits
Accident and Health Benefits are a type of health insurance policy that is purchased by companies on behalf of their employees. read more
Active retention is the practice of protecting against a loss via the designation of specific funds to pay for the expected amount of the loss. read more
Actual authority refers to specific powers, expressly conferred by a principal (often an insurance company) to an agent to act on the principal's behalf. read more
Actual Cash Value
Actual cash value is the amount equal to the replacement cost minus depreciation of a damaged or stolen property at the time of the loss. read more
An adjustable premium is an insurance premium that can change over time based on a policy that is agreed to at the outset of an insurance contract. read more