Insurance is a means of protection from financial loss. It is a form of risk management, primarily used to hedge against the risk of a contingent or uncertain loss. An entity that provides insurance is known as an insurer, an insurance company, an insurance carrier or an underwriter.
A person or entity who buys insurance is known as a policyholder, while a person or entity covered under the policy is called an insured. Policyholder and insured are often used as but are not necessarily synonyms, as coverage can sometimes extend to additional insureds who did not buy the insurance.
The insurance transaction involves the policyholder assuming a guaranteed, known, and relatively small loss in the form of payment to the insurer in exchange for the insurer’s promise to compensate the insured in the event of a covered loss. The loss may or may not be financial, but it must be reducible to financial terms, and usually involves something in which the insured has an insurable interest established by ownership, possession, or pre-existing relationship.
The insured receives a contract, called the insurance policy, which details the conditions and circumstances under which the insurer will compensate the insured, or their designated beneficiary or assignee. The amount of money charged by the insurer to the policyholder for the coverage set forth in the insurance policy is called the premium.
If the insured experiences a loss that is potentially covered by the insurance policy, the insured submits a claim to the insurer for processing by a claims adjuster. A mandatory out-of-pocket expense required by an insurance policy before an insurer will pay a claim is called a deductible (or if required by a health insurance policy, a copayment).
The insurer may hedge its own risk by taking out reinsurance, whereby another insurance company agrees to carry some of the risks, especially if the primary insurer deems the risk too large for it to carry.
Any risk that can be quantified can potentially be insured. Specific kinds of risk that may give rise to claims are known as perils. An insurance policy will set out in detail which perils are covered by the policy and which are not. Below are non-exhaustive lists of the many different types of insurance that exist. A single policy may cover risks in one or more of the categories set out below.
For example, vehicle insurance would typically cover both the property risk (theft or damage to the vehicle) and the liability risk (legal claims arising from an accident). A home insurance policy in the United States typically includes coverage for damage to the home and the owner’s belongings, certain legal claims against the owner, and even a small amount of coverage for medical expenses of guests who are injured on the owner’s property.
Business insurance can take a number of different forms, such as the various kinds of professional liability insurance, also called professional indemnity (PI), which are discussed below under that name; and the business owner’s policy (BOP), which packages into one policy many of the kinds of coverage that a business owner needs, in a way analogous to how homeowners’ insurance packages the coverages that a homeowner needs.
Vehicle insurance protects the policyholder against financial loss in the event of an incident involving a vehicle they own, such as in a traffic collision. Coverage typically includes:
- Property coverage, for damage to or theft of the car
- Liability coverage, for the legal responsibility to others for bodily injury or property damage
- Medical coverage, for the cost of treating injuries, rehabilitation and sometimes lost wages and funeral expenses
Gap insurance covers the excess amount on your auto loan in an instance where your insurance company does not cover the entire loan. Depending on the company’s specific policies it might or might not cover the deductible as well. This coverage is marketed for those who put low down payments, have high interest rates on their loans, and those with 60-month or longer terms. Gap insurance is typically offered by a finance company when the vehicle owner purchases their vehicle, but many auto insurance companies offer this coverage to consumers as well.
Health insurance policies cover the cost of medical treatments. Dental insurance, like medical insurance, protects policyholders for dental costs. In most developed countries, all citizens receive some health coverage from their governments, paid through taxation. In most countries, health insurance is often part of an employer’s benefits.
Risk which can be insured by private companies typically share seven common characteristics:
A large number of similar exposure units: Since insurance operates through pooling resources, the majority of insurance policies cover individual members of large classes, allowing insurers to benefit from the law of large numbers in which predicted losses are similar to the actual losses.
Exceptions include Lloyd’s of London, which is famous for insuring the life or health of actors, sports figures, and other famous individuals. However, all exposures will have particular differences, which may lead to different premium rates.
Definite loss: This type of loss takes place at a known time and place, and from a known cause. The classic example involves the death of an insured person on a life-insurance policy. Fire, automobile accidents, and worker injuries may all easily meet this criterion. Other types of losses may only be definite in theory.
Occupational disease, for instance, may involve prolonged exposure to injurious conditions where no specific time, place, or cause is identifiable. Ideally, the time, place, and cause of a loss should be clear enough that a reasonable person, with sufficient information, could objectively verify all three elements.
Accidental loss: The event that constitutes the trigger of a claim should be fortuitous, or at least outside the control of the beneficiary of the insurance. The loss should be pure, in the sense that it results from an event for which there is only the opportunity for cost. Events that contain speculative elements such as ordinary business risks or even purchasing a lottery ticket are generally not considered insurable.
Large loss: The size of the loss must be meaningful from the perspective of the insured. Insurance premiums need to cover both the expected cost of losses, plus the cost of issuing and administering the policy, adjusting losses, and supplying the capital needed to reasonably assure that the insurer will be able to pay claims.
For small losses, these latter costs may be several times the size of the expected cost of losses. There is hardly any point in paying such costs unless the protection offered has real value to a buyer.
Affordable premium: If the likelihood of an insured event is so high, or the cost of the event so large, that the resulting premium is large relative to the amount of protection offered, then it is not likely that insurance will be purchased, even if on offer. Furthermore, as the accounting profession formally recognizes in financial accounting standards, the premium cannot be so large that there is not a reasonable chance of a significant loss to the insurer.
If there is no such chance of loss, then the transaction may have the form of insurance, but not the substance (see the U.S. Financial Accounting Standards Board pronouncement number 113: “Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts”). ( article from https://en.wikipedia.org/wiki/Insurance)