What is insurance?

What is insurance?

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Insurance is a way to manage your risk. When you buy insurance, you purchase protection against unexpected financial losses. The insurance company pays you or someone you choose if something bad happens to you.

If you have no insurance and an accident happens, you may be responsible for all related costs. Having the right insurance for the risks you may face can make a big difference in your life.

An insurance policy is a written contract between the policyholder (the person or company that gets the policy) and the insurer (the insurance company).

The policyholder is not necessarily the insured. An individual or company may get an insurance policy (making them the policyholder) that protects another person or entity (who is the insured). For example, when a company buys life insurance for an employee, the employee is the insured, and the company is the policyholder.

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How does insurance reduce your financial risk?

Imagine you’re driving your car and you hit a deer, which damages your car. If you have the right kind of auto insurance policy, the insurance company will pay the costs of the car repairs (minus the deductible — the portion you have to pay).

Now, imagine a water pipe bursts in your bathroom, ruining everything in that room and in the bedroom next to it. Typically, if you have homeowner’s or renter’s insurance, the insurance company will pay to replace some or all of the damaged property, once you pay your deductible. Insurance policies will only pay for things that are described in the policy. So, it’s important to read a policy carefully before you buy it, so you’ll know exactly what’s covered.

How does an insurance policy work?

Insurance policies are often in place for a specific period of time. This can be referred to as the policy term. At the end of that term, you need to renew the policy or buy a new one.

When you buy an insurance policy, part of your responsibility includes paying a fee called a premium. Some premiums are paid monthly, like health insurance. Others may be paid once or twice a year, like auto or homeowner’s insurance. The cost of your premium generally depends on how much of a risk you are to the insurance company.

In addition to the premiums, most insurance policies include a deductible. That’s the amount you have to pay first, before the insurance company pays their share. For example, if you have a $500 deductible on your homeowner’s policy and a storm causes $3,000 in damage, you will pay $500 and your insurance company will pay $2,500. With some policies, you can choose your deductible. Usually, a higher deductible means a lower insurance premium.

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