The Basics of Insurance

Last Updated: September 23, 2018
The Basics of Insurance

Insurance is one of those things that most people have, but very few people really understand, like computers or cars. Except instead f lacking technical or engineering knowledge, in this case it's a matter of lacking the financial savvy to make smart choices. Here's the first article for those curious to know more about how insurance works.

Insurance is, at its core, risk management. Wherever there is a risk of something going wrong, whether it's your health, a car accident, or even legal troubles, insurance is your way of saying "I'm willing to pay X amount of money while things are going okay, so that just in case something goes really wrong, I'll have help managing it."

So what are the factors that go into determining insurance rates?

Underwriting

Underwriting is the evaluation of the risk you want to be ensured against. The insurance company will determine how likely the risk is, how much the loss will be, and then use that information to determine what you will pay to protect against the risk.

For example, car insurance companies are most interested in your driving history. If you have a lot of accidents on your record, they will increase the cost of how much you have to pay, because the risk of you getting in another accident is determined to be higher than average. There are also other factors, such as how much money the insurance would need to pay in the event of an accident: generally speaking, the more expensive the car, the more expensive the insurance.

Coverage

Coverage is the description of what the insurance actually will pay for. Most auto insurance covers personal injury, medical payments, emergency road assistance, and other damages to your car caused by floods or vandalism, for example.

When buying health insurance, coverage is one of the most important things to pay attention to. Recent legislation has made it much harder for insurance companies to refuse payment for certain illnesses, but there are some things that many health insurance still won't cover, like many treatments for mental health.

Premiums and Deductible

These two are linked because they have a very high inverse correlation: the Premium is how much you pay per month for the insurance, while the Deductible is how much you pay when something goes wrong that you want the insurance to cover. The higher your deductible is, the lower your premiums are.

So if you don't really expect anything to go wrong and you're confident that you can cover the basic risks, but you want to make sure that if something major happens you're not forced into bankruptcy, you might choose to pay low premiums every month, knowing that if you want to file a claim, you'll have to pay more out of pocket. On the opposite end, if you're sure something's going to go wrong and want better peace of mind, you might choose to pay a lot every month for the premium, just so that when something goes wrong, the deductible is very low and the insurance company pays most of the hospital or mechanic bills.

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