financial losses resulting from accidents, injury, or property damage. Insurance also helps cover costs associated with liability (legal responsibility) for damage or injury caused to a third party.1

KEY TAKEAWAYS

  • Insurance is a contract (policy) in which an insurer indemnifies another against losses from specific contingencies or perils.
  • There are many types of insurance policies. Life, health, homeowners, and auto are among the most common forms of insurance.
  • The core components that make up most insurance policies are the premium, deductible, and policy limits.

How Insurance Works

Many insurance policy types are available, and virtually any individual or business can find an insurance company willing to insure them—for a price. Common personal insurance policy types are auto, health, homeowners, and life insurance. Most individuals in the United States have at least one of these types of insurance, and car insurance is required by state law.

Businesses obtain insurance policies for field-specific risks, For example, a fast-food restaurant’s policy may cover an employee’s injuries from cooking with a deep fryer. Medical malpractice insurance covers injury- or death-related liability claims resulting from the health care provider’s negligence or malpractice. Businesses may be required by state law to buy specific insurance coverages.2

Most insurance is regulated at the state level.

There are also insurance policies available for very specific needs, such as kidnap, ransom and extortion insurance (K&R), identity theft insurance, and wedding liability and cancellation insurance.

Insurance Policy Components

Understanding how insurance works can help you choose a policy. For instance, comprehensive coverage may or may not be the right type of auto insurance for you. Three components of any insurance type are the premium, policy limit, and deductible.

Premium

A policy’s premium is its price, typically a monthly cost. Often, an insurer takes multiple factors into account to set a premium. Here are a few examples:3

  • Auto insurance premiums: Your history of property and auto claims, age and location, creditworthiness, and many other factors that may vary by state.
  • Home insurance premiums: The value of your home, personal belongings, location, claims history, and coverage amounts.
  • Health insurance premiums: Age, sex, location, health status, and coverage levels.
  • Life insurance premiums: Age, sex, tobacco use, health, and amount of coverage.

Much depends on the insurer’s perception of your risk for a claim. For example, suppose you own several expensive automobiles and have a history of reckless driving. In that case, you will likely pay more for an auto policy than someone with a single midrange sedan and a perfect driving record. However, different insurers may charge different premiums for similar policies. So finding the price that is right for you requires some legwork.

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