In one form or another, we all own/buy insurance. Whether it’s auto, medical, liability, disability or life, insurance serves as an excellent risk-management and wealth preservation tool. Having the right kind of insurance is a critical component of any good financial plan. While most of us own insurance, many of us don’t understand what it is or how it works. In this tutorial, we’ll review the basics of insurance and how it works, then take you through the main types of insurance out there.
What Is Insurance?Insurance is a form of risk management in which the insured transfers the cost of potential loss to another entity in exchange for monetary compensation known as the premium. Insurance allows individuals, businesses and other entities to protect themselves against significant potential losses and financial hardship at a reasonably affordable rate. We say “significant” because if the potential loss is small, then it doesn’t make sense to pay a premium to protect against the loss.
- Protecting family after one’s death from loss of income
- Covering contingent liabilities
- Protecting against the death of a key employee or person in your business
- Buying out a partner or co-shareholder after his or her death
- Protecting your business from business interruption and loss of income
- Protecting yourself against unforeseeable health expenses
- Ensuring debt repayment after death
- Protecting your home against theft, fire, flood and other hazards
- This is Protecting yourself against lawsuit
- Protecting yourself in the event of disability
- Protecting your car against theft or losses incurred because of accidents
Fundamentals Of InsuranceHow does insurance work? Insurance works by pooling risk. What does this mean? It simply means that a large group of people who want to insure against a particular loss pay their premiums into what we will call the insurance bucket, or pool. Because the number of insured individuals is so large, insurance companies can use statistical analysis to project what their actual losses will be within the given class.
RisksLife is full of risks - some are preventable or can at least be minimized, some are avoidable and some are completely unforeseeable. What’s important to know about risk when thinking about insurance is the type of risk, the effect of that risk, the cost of the risk and what you can do to mitigate the risk. Let’s take the example of driving a car.
Risk Control :There are two ways that risks can be controlled. You can avoid the risk altogether, or you can choose to reduce your risk.
Risk Financing :
Risk Sharing :Finally, you may also decide to share risk. For example, a business owner may decide that while he is willing to assume the risk of a new venture, he may want to share the risk with other owners by incorporating his business.
The Risk Management ProcessAfter you have determined that you would like to insure against a loss, the next step is to seek out insurance coverage. Here you have many options available to you but it’s always best to shop around. You can go directly to the insurer through an agent, who can bind the policy. The process of binding a policy is simply a written acknowledgment identifying the main components of your insurance contract.
- Captive Agents: Captive agents represent a single insurance company and are required to only do business with that one company.
- Independent Agent: Independent agents represent multiple companies and work on behalf of the client (not the insurance company) to find the most appropriate policy