Meaning of Insurance: How It Works and Its Benefits



Insurance is a form of risk management whereby two parties sign a legal agreement to cover unforeseen financial losses that a party (insured) may incur and the insurer i.e the insurance company agrees to compensate the insured in the event of a certain loss, injury or damage.

In the United States, Germany, and the United Kingdom, insurance can cover death (life insurance), vehicle damage (auto insurance), travel insurance, property damage (home insurance), medical expenses (health insurance), education insurance etc.

Its main components are the premium, deductible, and policy limit. The prospective insured needs to check them thoroughly and ask questions before signing the policy.


Key terms

Insurer: The entity that provides insurance services or compensates for other people’s loss is known as an underwriter, insurer, insurance company, insurance carrier, or underwriter.

Policyholder: A person or entity who buys insurance is known as a policyholder.

Insured: A person or entity covered under the policy is called an insured or policy buyer.

The premium: The amount of money an insurance company charges to the policyholder for the coverage agreed upon in the insurance policy.

Claim adjuster: A member of an insurance company, who processes a claim submitted by the insured.

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Deductible: This is the mandatory out-of-pocket expense required by an insurance policy before an insurer will pay a claim. This happens when the insured makes a claim and the premium amount is less than what it should be, meaning you must first pay the remaining amount before a claim can be settled.

Reinsurance: This is a situation whereby the primary insurer decides to transfer some insurance risks to another company when it believes that the risk is too large to bear alone. The primary insurer does reinsurance to hedge its own risk.

How insurance works

A business owner or individual or business entity to protect themselves from financial losses approaches an insurance firm and agrees to pay an applicable fee (a premium) based on the insurance policy, then if there is an injury or damage, the insurance company comes in the form of compensation to cover the losses. But it goes beyond just paying compensation.

The insured is given a contract or insurance policy to sign. The contract is similar to the T&C of a product, which succinctly explains the conditions and circumstances under which the insured or the designated beneficiary or assignee will be compensated when there is a loss.

When the insured experiences a loss or injury, he submits a claim to the insurer, having satisfactorily sure that the loss is covered by the insurance policy.

Benefits of Insurance

It creates a feeling of assurance

Insurance coverage gives the policyholders a filling assurance that there is something to fall back on in terms of reimbursement when unforeseen loss happens.

It boosts the morale of the insured and enables him to concentrate on more important aspects of their business and life while being rest assured that some financial aid would cover up for uncertainty that is covered by the insurance policy.

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Pooled investment

As for the insurer, the money that comes in (premiums) is a source of revenue generation for the company. It serves as a source of revenue generation, which can even be invested in short and long-term investments such as bonds, stocks, mutual funds, and high-yielding shares.

The returns from these sources serve as a financial reservoir for the insurance company which they can fall back on when the policy buyer asks for claims. The pooled investment helps the insured to ensure that the fees that come in through premiums do not lie idle in the bank account. This also helps to prevent any form of cash-flow issues that might arise.

Encourage saving culture

Insurance policies help the insured to be cautious of their spending. It encourages financial planning. You don’t want to default on the premium payment, as such every penny you spend isn’t impulse spending or buying.

In the real sense of financial planning, insurance coverage is like saving for the future and mitigating exigencies of life. It’s like saving for a rainy day.

Reduces the impact of loss

Certain things happen in life that are beyond our control, they are unplanned, they just happen when you least expect them. But Insurance coverage helps reduce the impact of such loss in times of crisis and emergency.

Risk mitigation

No insurance company wants hazard to befall their policy buyer.  Most times, the insurer provides guides and safety tips to minimize hazards.

These tips and guides not only help the insured but also help the company to minimize or reduce the amount it pays in the form of claims. It’s a win-win situation.

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It boosts financial stability

Insurance policies help rake in domestic savings that provide financial stability to an economy. The premiums they invest in other yield-yielding investments help provide liquidity into the system, which leads to financial stability.

Featured image by Vlad Deeep

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