Introduction to Insurance

What is Insurance?

Insurance is a type of contract that transfers the risk of something bad happening to an insurance company. In exchange for paying a fee or premium, the insurance company promises to help cover the costs of the unexpected event.

Financial Impact

The main goal of insurance is to reduce the financial impact of an unexpected event. When people have insurance, they are less likely to worry about the costs associated with a bad situation because they know they will have help paying for it.

How Does Insurance Work?

Insurance works by spreading the risk of financial loss among many people. This is called pooling and diversifying risk. Imagine a group of 100 people who all buy insurance policies. Chances are, not all of them will have a bad event happen simultaneously. So, the insurance company can use everyone's premiums to help pay for the losses of the few who experience a problem. This way, everyone in the group has some protection against unexpected events.

Who is Involved in an Insurance Transaction?

There are a few key players in an insurance transaction:

• The insured: That is you! The person who buys the insurance policy.

• The insurer: The insurance company that sells the policy and agrees to pay for the covered losses.

• The agent: The person who helps you buy the insurance policy. They represent the insurance company or work independently to find the best policy for you.

• The underwriter: The person at the insurance company who decides how much risk they are willing to accept and how much to charge for the premium.

Insurance Premiums

Insurance companies use math, specifically probability and statistics, to figure out how likely it is that someone will have a loss that they need to help pay for. They look at information about a person, like their age, where they live, and other factors, to estimate how likely it is that they will experience a covered loss. Then, they use this information to set the premium price. The higher the risk, the higher the premium.

Insurance Terminology

There are a few important terms that are used in insurance:

• Premium: the amount the insured pays to the insurance company to have coverage
  
  
• Deductible: the amount the insured must pay out of pocket before the insurance company will pay for a claim
  
  
• Co-pay: a fixed amount the insured must pay each time they receive a service that is covered by their insurance policy
  
  
• Policy limit: the maximum amount the insurance company will pay for a claim
  
  
• Claim: when you ask the insurance company to help pay for a covered loss, you make a claim.
  
  
• Benefit: the amount the insurance company agrees to pay when you make a claim.

Examples of How Insurance Terms are Used

Different types of insurance policies use these terms in different ways.

For example, a home insurance policy might have a policy limit of $40,000. If someone's house is damaged in a fire, the insurance company will only pay up to $40,000 in claims.

Another example is with health insurance. A policy might have a co-pay of $30 for specialist visits. Every time someone sees a specialist, like a dermatologist or cardiologist, they must pay out of pocket, and the insurance company will cover the rest.

Also, a car insurance policy might have a deductible of $500. If someone gets into an accident and their car is damaged, they must pay the first $500 out of pocket before the insurance company will step in and pay the rest.

Finally, a life insurance policy might have a premium of $300 per year. This means that the person must pay ‍the insurance company $300 each year to keep the policy active.

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Source: Khan Academy, https://www.khanacademy.org/college-careers-more/financial-literacy/xa6995ea67a8e9fdd:insurance/xa6995ea67a8e9fdd:insurance-basics-and-terminology/a/introduction-to-insurance
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