Insurance Definition: Types of Insurance And How They Work

What is Insurance definition? Insurance is a legal contract between two parties- the insurance company (insurer) and the individual (insured). The Insurance company promises to compensate for financial losses due to insured contingencies in return for the premiums paid by the insured individual.

Insurance Definition

Insurance Definition

Simply put, insurance is a risk transfer mechanism, where you transfer your risk to the insurance company and get the cover for financial loss that you may face due to unforeseen events. And the amount that you pay for this arrangement is called a premium. There is insurance available for various risks, starting from your life to mobile phones that you use. Insurance is highly recommended for everyone that have any value that is insurable.

How Does Insurance Work?

The concept of insurance works on the basis of ‘risk pooling’. When you buy any type of insurance policy from the insurance company for a specified period with specific cover, you will make regular payments (referred to as premiums) towards the policy. Similarly, the Insurance Company collects premiums from all of its clients (referred to as insured) and pools the money collected to pay for losses arising out of an insured event.

In case the insured event takes place, and you make a claim, losses will be compensated by the insurance company from the pool of policyholder’s premiums. In case you don’t make a claim during the specified policy period, no benefits will be paid to you. However, there are various types of products offered by insurance companies today which also involve savings elements attached to it.

Types of Insurance Products

There are different types of insurance products. However, insurance products are classified into:

  • Life insurance products
  • General insurance products

Life insurance covers you against the risk of death. Life insurance policies come in many variants such as term plans, endowment plans, whole life insurance plans, money back plans, and unit-linked investment plans, etc. Many life insurance products can be a great tool for long-term savings also as it comes as a combination of protection and savings. General insurance products cover financial losses caused by various risks other than death. General insurance products come in various types covering a wide range of risks such as health insurance, motor insurance, marine insurance, liability insurance, travel insurance, and commercial insurance, etc.

Insurance is an effective risk management tool that protects what is precious for us –life, health, home, and businesses, etc. The requirement of insurance may vary from one individual to another, but there are certain types of insurance products that are must-have for every individual for ensuring a secure future.

The Types of Insurance products

Knowing the importance of insurance is the need of the hour. Following insurance products are the must-have for any individual today.

Life Insurance

As no one wants to leave their loved ones financially shattered, life coverage is one of the must-haves for every individual having dependents. In the case of life insurance, the sum assured or the coverage amount will be paid out to the nominee of the insured in the event of the death of the insured. Life insurance is a crucial requirement to ensure the financial well-being of your loved ones even in your absence. The coverage amount opted should be able to provide complete financial protection – to replace income loss, to repay debt, and also to create a financial buffer that can be utilized by the insured’s family for future financial stability.

Health Insurance

Health uncertainties are part of life. Keeping in mind the rising cost of healthcare and an increasing number of diseases, it’s important to have the financial cushion to protect yourself against health contingencies. Health insurance policies are of many types such as individual health insurance, family floater health insurance, critical illness health insurance, and senior citizen health insurance. It’s important to have adequate health insurance coverage that can protect you from financial crisis during medical emergencies.

Motor Insurance

Motor insurance policies are the most commonly held type of insurance. It’s compulsory to avail of third-party liability motor insurance to protect oneself against the claims that may arise from another party during an accident. However, motor insurance policies come in a comprehensive package wherein your valuable assets (bike or car) are covered against the various risk of damage or loss along with the personal accidental cover to you as the owner.

Accident and Disability Insurance

Accidents are unexpected and are inevitable. Sometimes accidents can result in disabilities that can further have a huge impact on your earning capacity. In order to have financial stability for yourself and your family, it’s important to be insured against accidents.

Home Insurance

Home is one of your most valuable possessions that also includes many precious belongings and memories. Though you try to secure it to the fullest, your property is exposed to various risks like theft, damages due to natural disasters, and more. which you may not be able to mitigate completely. Hence, in order to protect your home against losses and damages that may arise due to many insurable events, availing of home insurance is the most effective solution.

Though you need to be prepared for future uncertainties by availing of insurance cover, you may not need all types of insurance. The priority of any insurance product may vary depending on your individual need. Insurance is a large industry with numerous product types available to cater to every sort of need. Some of them mentioned already are of top priority for every individual.

How to Decide on The Type of Insurance You Need?

Before you buy any insurance, it’s important to understand the need for insurance. Here are certain things to keep in mind at the time of deciding what type of insurance you need.

  • Purpose of cover
  • Risks that you want to be covered against
  • How long you might need the coverage
  • Affordability

Benefits And Importance of Insurance

Having an insurance policy is not only beneficial to individuals but also to everyone including the government. Following are some of the important benefits of insurance:

Provides Peace of Mind

Insurance provides protection against various uncertainties that can put you or your family in a financial crisis. By covering the uncertainties of human life and businesses, insurance provides a sense of security. Having life insurance gives you peace of mind that the financial stability of your family will remain intact even when you are not around. Having health insurance gives you a sense of security that you do not need to shell out all your savings in the event of medical emergencies.

Promotes Risk Control

As insurance works on risk transfer mechanisms, it promotes risk control activity.

Promotes Economic Growth

As insurance funds are invested in various projects like water supply, power, and roads, etc. It contributes to the overall economic growth of the nation. Also, insurance provides employment opportunities to people. Insurance contributes to economic growth in many other ways such as getting Foreign Direct Investment. And, also paying taxes on the profit earned, and by investing in the capital market, etc.

Distribution of Risk

The risk of insurance is spread across various individuals and organizations instead of concentrating on only one.

Helps to Get Loan Easily

There are loan facilities offered against insurance policies. In the case of home loans, having an insurance cover can help to get the loan easily from the lender.

Inculcates Savings Habit

There are many life insurance products that come with investment cum protection benefits. Such products inculcate a regular saving habit among individuals. Plans like endowment insurance plans help in achieving long-term financial goals. Pension plans help to receive regular income flow in older age.

Provides Tax Benefit

Insured gets the tax benefits for premium paid depending on the insurance product type. For example, the premium paid towards life insurance plans qualifies for tax deduction under Section 80C of the Income Tax Act. And, the premium paid towards health insurance plans qualifies for tax deduction under Section 80D of the Income Tax Act.

Insurance is the most effective risk management tool which can protect individuals and businesses from financial risks arising out of various contingencies.

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