Insurance, Meaning, Implications, and the way it works
Uncertainty in life is inescapable. Huge losses may be caused by accidents, diseases, natural disasters and other unexpected events. These happenings may be unavoidable but can be trained against their economic impacts. In this case the insurance comes in picture; a system that insures people, families and companies against the risk of monetary loss.
An insurance is a contract between an individual or a company (the policyholder) and an insurance company (insured) whereby the insured is guaranteed to receive payment on the occurrence of some losses, damages, illnesses or even deaths as a financial compensation in exchange of a payment referred to as a premium.
In simple terms:
You can pay at a regular rate.
In case of a covered event, the insurance company assists you in a monetary recovery.
It is merely just a risk management tool - one that increases the risk of loss to you to the insurer.
2. Key Components of Insurance
In order to say everything about insurance, you have to be aware of its central aspects:
a) Policyholder
The individual or organization that insured.
b) Insurer
The insuring company.
c) Premium
The amount of money that has to be paid to the insurer (monthly or quarterly or annually) to maintain the cover.
d) Policy
The contract in writing specifying coverage terms, conditions, limits and exclusions.
e) Coverage
What risks/events will the insurance cover.
f) Claim
A request by the policyholder to the insurer for payment after a covered loss.
g) Deductible
It is the sum that a policy owner is required to pay him/herself before the insurer will cover the balance.
3. How Insurance Works
The insurance works based on the risk pooling principle:
A lot of individuals contribute premiums in a pooled fund.
A covered loss will only be experienced by a few.
The collective funds are used by the insurer to make payments.
In this manner, no particular individual has the entire financial liability of a misfortunate occurrence - the burden is distributed.
Example:
Assuming that 10,000 individuals pay 500/year insurance on cars, the insurance company gets 5 million. When there is a pool of 500 people and each individual makes an accident that costs 10,000, the amount of money that will be paid is 5 million, which will be paid through the pooled funds.
Insurance takes place against some legal ethical principles:
Utmost Good Faith- Both parties are required to be truthful and to present all pertinent facts.
Insurable Interest – It is only something to which you have a financial interest (e.g. your own car not that of a stranger).
Indemnity - Insurance will not indemnify you beyond your actual loss.
Contribution -When there are more than one policies covering the same risk, the payout is shared amongst the insurers.
Subrogation- The insurer is allowed to recover on the party that caused the loss after making payment to you.
Proximate Cause -Claims are not paid until loss is a direct result of insured event.
5. Types of Insurance
Insurance can largely be classified into two; life insurance and general insurance.
A) Life Insurance
Covering life of the covered. Provides a lump-sum payment to beneficiaries upon death or after a fixed term.
Term Life Insurance – Protection for a specific period.
Whole Life Insurance – Lifetime coverage with savings component.
Endowment Plans – Combination of insurance and savings.
Covers everything except life.
Health Insurance – Covers medical expenses from illness, injury, or hospitalization.
Motor Insurance – Protects against vehicle damage and third-party liability.
Home Insurance – Covers damage to property from fire, theft, natural disasters.
Travel Insurance This is used to cover trip cancellation, lost luggage, overseas health crises.
Business Insurance- Commercial (e.g. liability, property, workers compensation).
6. Importance of Insurance
Insurance is very important in personal and economic stability.
a) Financial Protection
Meets huge, unforeseen costs that otherwise would drain savings.
b) Peace of Mind
It is less stressful when you know you are financially covered in an uncertain situation.
c) Strongs Savings and Investment.
Some of the insurance products are wealth-building and protection combined.
d) Business Continuity
Protects companies from operational risks, lawsuits, and disasters.
e) Supports the Economy
Insurance companies allow the economy to grow and stabilize through the pooled risks.
7. Example Scenarios
Scenario 1 – Health Insurance:
You fracture your leg and the hospital invoice is 5000. On insurance, the only amount you pay is the deductible at 500 and the insurer takes care of the rest of 4,500.
Scenario 2 – Car Insurance:
You have an accident with your car in which you have spent 2,000 dollars. Your policy provides deductible of 200 dollars and you pay after repair.
Scenario 3 – Life Insurance:
You have a $200,000 term life policy. When you die within the policy term, your family is provided with the lump sum in order to compensate the lost income.
8. Influencing Factors of the Insurance Premiums.
The basis of calculation of premiums is the perceived risk to the insurer that you pose.
Common factors include:
Age- The younger individuals tend to have lower life and health insurance.
Health status- Preexisting conditions could increase the cost of premiums.
Personal habits of life- Smoking or dangerous leisure adds to expense.
Occupation -Dangerous occupations are subject to increased premiums.
Coverage amount -The more coverage, the more premiums.
Place -There are accident or theft hot spots.
9. Common Misconceptions About Insurance
I feel well, I do not need insurance.
– The accidents and illnesses may occur unexpectedly. It is more a matter of readiness than present health.
Insurance is nothing to waste when I do not take advantage of the insurance.
- Insurance is insurance, like a safety belt you are buying peace of mind.
"All insurance is the same."
– Policies have large differences in coverage, limits and exclusions.
"Cheaper is always better."
– Cheap premiums may bode small cover.
10. Insurance advice on the advice to take.
Assess your needs – Life stage, dependents, health, assets.
Compare policies- Compare coverage, exclusions and claim settlement ratio.
Read the small print - Read the fine print before purchasing.
Select a well-known insurer Customer service and claim processing.
Review once a year - Periodically change your coverage by the changes in your situation.
11. Challenges and Limitations
Even though insurance is needed, it is limited:
Exclusions - There are other events which are not covered (e.g., intentional damage).
Claims rejections -because of non-disclosure or breach of policy.
Increased premiums -particularly in health insurance.
Complexity- Policies may be too hard to be comprehended by the common man.
In Conclusion
Insurance is a guarantee of financial protection - a pledge that your finances will not be hurt by the economical uncertainties of life. It functions through the centralization of risks, and in a situation where the financial burden of a few is distributed among many.
It may be life insurance to secure your family future, health insurance to pay your hospital bills, or property insurance to protect your property in case of a crisis, the right insurance can spell the difference between financial destruction and stability.
The trick is to know what you need, select right coverage and make insurance a component of a bigger financial strategy. Insurance doesn’t only save your money, but it saves your peace of mind and future, with the right approach.
