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Course: Financial Literacy > Unit 6
Lesson 2: Insurance basics and terminologyIntroduction to insurance
Understanding different insurance options helps keep you and your family protected from life's surprises, giving everyone some extra comfort and peace of mind in our ever-changing world.
What is insurance?
Insurance is a type of contract that transfers the risk of something bad happening to an insurance company. In exchange for paying a fee or premium, the insurance company promises to help cover the costs of the unexpected event.
Financial impact
The main goal of insurance is to reduce the financial impact of an unexpected event. When people have insurance, they are less likely to worry about the costs associated with a bad situation because they know they will have help paying for it.
How does insurance work?
Insurance works by spreading the risk of financial loss among many people. This is called pooling and diversifying risk. Imagine a group of 100 people who all buy insurance policies. Chances are, not all of them will have a bad event happen at the same time. So, the insurance company can use the money from everyone's premiums to help pay for the losses of the few people who do experience a problem. This way, everyone in the group has some protection against unexpected events.
Who is involved in an insurance transaction?
There are a few key players in an insurance transaction:
- The insured: That's you! The person who buys the insurance policy.
- The insurer: The insurance company that sells the policy and agrees to pay for the covered losses.
- The agent: The person who helps you buy the insurance policy. They represent either the insurance company or work independently to find the best policy for you.
- The underwriter: The person at the insurance company who decides how much risk they're willing to accept and how much to charge for the premium.
Insurance premiums
Insurance companies use math, specifically probability and statistics, to figure out how likely it is that someone will have a loss that they need to help pay for. They look at information about a person, like their age, where they live, and other factors, to estimate how likely it is that they'll experience a covered loss. Then, they use this information to set the premium price. The higher the risk, the higher the premium.
Insurance terminology
There are a few important terms that are used in insurance:
- Premium: the amount the insured pays to the insurance company in order to have coverage
- Deductible: the amount the insured must pay out of pocket before the insurance company will pay for a claim
- Co-pay: a fixed amount the insured must pay each time they receive a service that is covered by their insurance policy
- Policy limit: the maximum amount the insurance company will pay for a claim
- Claim: when you ask the insurance company to help pay for a covered loss, you're making a claim.
- Benefit: the amount of money the insurance company agrees to pay when you make a claim.
Examples of how insurance terms are used
Different types of insurance policies use these terms in different ways.
For example, a home insurance policy might have a policy limit of
Another example is with health insurance. A policy might have a co-pay of
Also, a car insurance policy might have a deductible of
Lastly, a life insurance policy might have a premium of
Want to join the conversation?
can someone tell me what insurance is in simple terms.(1 vote)
It should be simple enough in the lesson, but here goes:
Insurance is a bet you make with an insurance company. You bet that something bad is going to happen, like a fire, an accident, a flood, or a death. You make that bet with the insurance company every year. If the bad thing happens, the insurance company pays for the damages. If the bad thing doesn't happen, the insurance company keeps your money.
In the case of life insurance, you are betting that you will die, and the insurance company is saying that you won't, So, if you win the bet (you die), someone else gets the money from the insurance company. But if you lose the bet (you live), the insurance company keeps your money.(16 votes)
Does the amount you must pay for your insurance depend on your records? For example, in the car insurance example mentioned in the video, would they give a higher rate to someone who crashed their car twice in the last five years than to someone who has never crashed their vehicle in their five years of driving? If yes, for which insurance do they check your records? What information would they check for?
P.S. I'm sorry if this question is long. I just wanted to be specific.(3 votes)- An accident that was manifestly your fault results in higher premiums for years. Even an accident that was "the other driver's fault" can count against you, but not as much as when it is your fault.
Insurance companies are very skilled at checking records.(4 votes)
what does benefit mean in simple words(2 votes)- A benefit is a good thing. The word root bene means "good."(2 votes)
I'm struggling to differentiate between COPAY and DEDUCTIBLE. May someone care to explain?(1 vote)- A copay is a fee you pay each time you see the doctor. So, let's imagine that the doctor charges $100 for a visit. Your insurance says that you must pat at least $25 of it. THAT's a Copay.
The deductible is an annual amount that you pay first. So, let's imagine that your insurance policy says that your deductible is $2000 every year. That means you must pay the first $2000 of your expenses IN FULL, after which the insurance company pays a high percentage of what is left. Maybe 75 or 80 percent of the rest.
SO, let's now imagine that you have a medical condition that has required you to visit the doctor one time every month. The Doctor charges $100 each time and your copay is $25. The doctor sends the bill to the insurance company which informs you that you owe $300 (12 visits copay). Because your deductible is $2000, you also owe all the rest (the remaining $900) BUT, now you have a remaining deductible of $800. Then, you break a leg, and the emergency room charges: drugs, xrays, treatment and such, comes to 6
$6000. Well, to start, you owe the remaining $800 (your deductible), and then let's say 25% of the remaining $5,200, so an additional $1300. Because you are insured, you have been liable for $7200 of expenses this year, but have only paid $3,300.
Health insurance usually pays for the Big things. So, let's say that your policy says, "YOu pay 25% of everything between $2000 and $25,000. The company pays 100% of the charges over $25,000. So, if you need a heart transplant, you'll likely pay only $7,750 plus $50 every time you go to the doctor's office. The insurance company will pay the rest of the 1.6 million dollars.(3 votes)
Is copay a percentage?(1 vote)- No. A copay is a dollar amount that is part of the contract you have with your insurance company. You pay the same copay for a $100 doctor appointment as you do for a $500 one.(1 vote)
- I am confused about what is the difference between co-pay and deductible(1 vote)
- I answered that for someone else within the past couple of weeks. Set the "sort by" box to recent, and scroll down. You'll find it.(1 vote)
what does benefit mean in simple words(1 vote)- "bene" is the Latin word root which carries the meaning of "good" (like benediction in church, which is "good word") A benefit is a good thing.(1 vote)