How Does Insurance Work?

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Introduction

Insurance provides people and companies with protection against major financial losses due to damage or loss of property. In exchange for a periodic payment or premium, individuals and companies are guaranteed to be compensated or reimbursed under the terms of the insurance policy. Insurance is a part of daily life. Car insurance and homeowner's insurance are two of the most common forms of insurance. Health insurance and workmen’s compensation are also well-known types of insurance. While insurance is a part of most people’s lives, not everyone understands how it works.

How Insurance Works

There are always risks in life such as fire, theft or earthquake. Many people hope to avoid the financial consequences of replacing personal property that is lost or damaged. Insurance is a way to protect your personal finances from undue burdens. Insurance is really a form of risk management in which the risk is transferred to the insurance company in exchange for payments or premiums. When a person purchases insurance, he gets an insurance policy which is a legally binding contract. This policy describes in detail all the rights, responsibilities and obligations of both the insured and the insurance company. If a person suffers losses covered in the policy, he files a claim. A claim is a detailed account of what is lost or damaged and its value. The amount of money a person is reimbursed is based on the amount of the policy. If the policy is for $5,000 that is the maximum amount the insured person can get.

When individuals or companies purchase insurance policies, all the money from the premium is combined into what is called the insurance pool. Insurance companies use statistics to predict what percentage of insured people or businesses will actually suffer a loss and file a claim. The statistics also help to determine the amount of the premium. Other factors such as credit scores and previous claims are also taken into consideration. Because the vast majority of insured people do not suffer losses or only small losses, the insurance companies make a huge profit which enables them to pay out the occasional huge claim.

Types of Insurance Available

There seem to be insurance policies available for any situation. Anything that has a potential risk of loss or damage can be insured. One policy can cover several areas of risk such as a homeowner’s policy dealing with fire, theft and liability. Some of the more common kinds of insurance are renter’s, life, disability, liability, travel and pet insurance. Companies have political risk insurance if they do business in politically unstable countries. Crime insurance protects against theft or embezzlement. Property insurance protects against loss of boats, planes, and farm crops. Boiler insurance is for machinery and equipment. Credit insurance provides protection for loans if the borrower should die, becomes disabled or lose his job. There is insurance to protect against natural disasters such as flood, windstorm, earthquake and volcano. Nuclear accident insurance is also available as is kidnap and ransom insurance and terrorism insurance. In considering any of these types of insurance you have to assess your situation and determine what is best for you, your family and your business.

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