All choices can involve risk, but there are ways that you can reduce it. Insurance is one way to minimize some of the risks in life.
You and your family can purchase life, health, auto, disability, and other insuranceA contract guaranteeing payment of a sum of money in the event of loss or damage to property or a life. Insurance may also guarantee medical services. Policies are secured by regular payments (premiums) made by the consumer. to protect what you own and/or your income if you should become disabled. Whatever you as an individual or an organization wants to insure, there is usually insurance to cover it.
Purchasing insurance is an economic decision involving costs and benefits, and is based on your assessment of riskUncertainty as to the outcome of an event. The chance of loss. A person or thing insured. . Buying insurance is a way that you can set aside part of your current income to meet future needs arising from uncertainties. In some instances, purchasing insurance is legally required — car insurance is one example.
Sharing the Risk
You might ask how insurance companies can take in relatively small amounts of money for premiums and yet pay out very large sums if an accident or other hardship occurs. Major insurance companies sometimes have millions of policyholders who pay premiums, but only a small percentage might ever receive a payment for a loss. Insurance companies are state regulated and have to place enough money in reserve to pay policyholders when claims are made. Beyond that reserve, insurance companies invest the premiums they collect in bonds, stocks, and other financial instruments. The interestAn amount of money paid for using funds over a period of time, generally an annual percentage rate. Bank interest is both an amount paid to depositors of funds and a finance charge for money that is borrowed. The price that someone pays for the temporary use of someone else’s funds. Interest is also a compensation that someone receives for temporarily giving up the ability to spend money. and dividendsThe portion of a company’s profits that the firm pays out each period to shareholders. Also called distributed profits. are used to pay employees, expenses, and also their own company shareholders.
Risks and Uncertainties
Insurance is a way to manage or reduce financial risks. Read how insurance protects you and your assetsAnything of value owned by a person or business (can also include money owed to a person or business). and why individual insurance needs change over time.
Risk is something that people consciously (or often instinctively) try to avoid. The definition and tolerance of risk varies greatly from one person to another. Recall ways you may have personally avoided risk in the past week. A few examples:
- crossing the street only in crosswalks
- locking your house or apartment every time you leave
- walking in pairs at night
- using a helmet for bicycle riding or skateboarding
- protecting privacy on the Internet
- keeping dog on leash in park
Every decision to avoid risk involves a choice as well as the acknowledgment that accidents can happen no matter how careful you are. There will always be events that are totally beyond your control (e.g., hurricanes, floods, earthquakes, or falling trees and electric wires, or becoming the victim of a speeding, out-of-control driver). Most people believe that since life is full of risks and uncertainties they need some protection. That is why people buy insurance.
Most people would find it impossible to save enough money to cover all the emergencies and uncertainties that could occur in life.
Types of Insurance
- Life insurance
- The primary purpose of life insurance is to provide income to dependents after the policy holder’s death. The two basic types of life insurance are temporary (term) and permanent (whole), the former is offered for fixed-time periods (usually one year at a time, renewable); the latter for as long as the insured person desires it. Term life insurance costs less and can more easily be terminated (e.g., after the insured person retires). Whole life insurance is also a savings plan (eventually the cash valueThe amount available in cash upon surrender of an insurance policy before it becomes payable upon death or maturity of the premiumAn amount to be paid for a contract of insurance. A sum added to interest, wages, etc; a bonus. payments can be recovered with interest).
- Health insurance
- Health insurance pays for medical treatment required by the insured and his or her dependents. Often employers pay part or most of the cost of health insurance premiums. These are called group plans. Individuals can buy health insurance plans, but they are usually more expensive than a group plan. The older you are, the more expensive health insurance premiums generally become. Individual and group health insurance plans often include a co-pay provision. This means that the insured has to pay a share of the cost of medical treatment.
- Disability insurance
- People can buy private disability policies that provide income over a specified period of time, if they become seriously ill and unable to work.
- Auto Insurance
- If you own a car, you are required to have automobile insurance. Auto insurance rates are higher for young people because they pose a greater risk (the reasoning is the same as why health insurance is higher for older adults). Factors, other than age, that could influence the cost of automobile insurance are accident records, number of moving violations, driving under the influence [DUI] arrests, model or year of car, etc. The higher the risk factor, the higher the cost of insurance premiums.
- Bodily Injury (BI) Liability
- This is mandatory coverage in case any driver listed on the policy causes people (who are not passengers in the insured car) to be injured.
- Personal Injury
- This optional insurance pays for medical treatment for the driver and passengers of the insured car.
- Property Damage (PD) Liability
- Required coverage that pays for damage to someone else’s property (i.e., automobile).
- Optional coverage for damage to the insured vehicle from collisions and potholes.
- Optional coverage for loss to the insured vehicle or any property in it, due to theft, fire, falling objects, flood, collision with an animal, hail, and earthquakes.
- Uninsured and Underinsured Motorists
- Required coverage that reimburses the driver of an insured vehicle, if it is hit by a vehicle operated by an uninsured, underinsured, or hit-and-run driver.
- Renter’s Insurance
- When making a decision to purchase renter’s insurance, compare the total cost of replacing the items covered with the cost of renter’s insurance, which often costs less than $300 per year.
- COBRA provides certain former employees, retirees, spouses, and dependents a temporary continuation of health insurance coverage at a group rate.