What is Insurance? Beginner’s Guide

What is Insurance?

Insurance, as the word sounds, is actually insuring someone or something from losses like physical loss, financial loss or like such.

But the word Insurance has become so much related to the finance that it is defined as a means of protection from financial loss.

Insurance is a form of risk management used as a boundary to prevent from an uncertain loss. It can be said as a guarantee to be helped in bad times. Risk management involves basically 3 steps :-

  • Identify the risk
  • Evaluate the dynamics of the risk
  • Then act accordingly and priority wise to either minimize or vanish the impact of the loss

There are various terms related to insurance which needs to be understand before jumping into complex part. These terms are :-

Insurer :-  It is an entity generally a company or organization which actually provides insurance. It can also be called as insurance company or an underwriter.

Insured :-  It is a person or entity that buys insurance from those companies upon paying regularly some amount of money. It is also known as policyholder.

Policy :-  It is actually a paper agreement between insurer and the policyholder which needs to be abided by both.

Premium :-  This is that amount of money which a policyholder needs to pay insurer periodically as depicted in the policy. 

How does insurance works? There is a legal contract agreement between Insurer and the policy holder under which all the circumstances are written under which the insurance company will pay or not pay you or in case nominee the amount equivalent to the loss. 

For this the policy holder has to pay a regular might be monthly or yearly called premium which is generally affordable amount. The premium you have to pay is written in the policy agreement and decided by the company according to the frequency or extent of the risk.

Take an example –
You have bought a car and took the car insurance for it from an insurance company taking into consideration that the company will cover your expense in case loss happens. You paid premium, for instance, $15 annually as depicted in the contract.

If your car damaged due to accident or other some other reason, you have to claim the insurance cover for your expense. The Insurer will verify your claim and finally provide you the amount.

If you don’t claim your cover or there is no such loss happened with you, the company will not provide any amount doesn’t matter how much premium you have paid till the time. And this way the Insurance company make profit.

How premiums are calculated? No doubt the Insurance companies are not charitable organization. They are mean to make profit from their Insurance business. These companies use risk data to evaluate wisely what would happen in the future and charge premium accordingly.

Generally these companies take these two things into consideration while calculating applicable premiums to be paid by insurer –

  • Frequency of the risk :- which means what is the probability of the loss risk and how likely the policy holder can claim for coverage. This would be different for different person.
  • Extent of the risk :- this means, if loss happens, then what amount the Insurance companies have to pay for the coverage. This would be different for different cases.

For example, an stuntman getting Insurance for his/her car would definitely be charged more premium than a normal person taking insurance for his/her car. This is because, an stuntman is more prone to accidents.
Similarly, home insurance premiums are more for those located in the earth-quake or tsunami prone areas.

What is the Business model of Insurance companies?

As mentioned above that Insurance companies are not charitable organization, they are mean to make huge profit from their businesses. 

Insurance companies have a team of highly qualified business professionals that managed to get the company profit in almost every conditions. Ya, some time they might fails and get some loss too.

The business models of insurance companies are unique to every company based on various factors that ensure they do not suffer losses and always enjoy humungous profits.

The premiums paid by policy holders are one of the biggest asset for an Insurance companies. 
Take an example, 100 clients have applied for any particular Insurance.

They paid their premiums regularly. Lets suppose 10 out of them got certain loss and claim for their coverage. Suppose the company verified the claims and found only 6 out of 10 claimers are legitimate and meet the conditions as depicted in the policy. Then the Insurance company has to pay the coverage to only those 6 clients.

Those 97 clients would not get anything, doesn’t matter how much premiums they have paid till. The premiums of those 97 clients are one of the income source of these companies.

As per the recent industry data, only 3% of clients who pay their insurance premiums every year make a claim. 

Not just that, if the policy holder stop paying premiums for some time, then the policy agreement will broke and the Insurer company get profit from it.

Also, If the Policy holder wants to get all his money back before the policy ends, then the Insurance company will return those amount which they have earned from interest on the investment made from the premium they have taken from the client.

Now what Insurance companies do with the premiums they have collected, they Invest it in various quick money making business. The wise investment make these amount increase many times. The Interest return profit from these investments are such huge that even after few clients claim coverage, the company has left with lots of money in their account.

So this is the whole transparent business model of an Insurance company. But different companies also have some of their different hidden source of income for the assurance of making profit in every instance.

Types of Insurance

Depending on the thing or cause for which Insurance policy is taken, it is categorized as different types. Every types differ in term and regulations. They also differ in the amount of premiums to be paid. Some common types of Insurance around the world are :

  • Property Insurance : These are the type through which a policy holder ensure his/her building property whether resident or commercial. These also include things inside the building.
  • Health Insurance :  This policy type covers financial assistance when the policy holder gets admitted to hospitals for treatment bearing all the expenses from treatment to medicine.
  • Vehicle Insurance : This is the most widely used Insurance type as majority of the people use to buy vehicle from their hardly earned savings and vehicle are more prone to get damaged. The policy covers the financial assistance in the case of damages. This include all types of vehicles from 2-wheeler to mega trucks.
  • Travel Insurance : This might be one of the cheapest Insurance policy where any traveler choose to get financial coverage in case of losses or damages during travel.
  • Life Insurance : Life Insurance is a serious type of policy where the policyholder ensure financial freedom for his/her family members after death. His/her family would get financial assistance by the Insurance company.

Top companies providing Insurance in the US

Below is the list of some of the prominent Insurance companies based in the united states. These are big in the sense of total assets, number of customers and trust value.

  • Prudential Financial
  • Berkshire Hathaway
  • MetLife Inc.
  • Teachers Insurance and Annuity Association of America
  • American International Group Inc (AIG)
  • Lincoln National Corporation
  • New York Life Insurance
  • Massachusetts Mutual Life Insurance
  • Northwestern Mutual
  • State Farm Insurance

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