What is Insurance – Definition, Types and Benefits

 

Ever thought how a family copes, if the sole earner dies an untimely death?

Or, what happens if a fire devastates a house and people living in it are suddenly homeless?

With unfortunate events come monetary loss that impacts your financial stability. This is where insurance can play a role.

So, what is insurance? Designed to safeguard your financial foothold, insurance is an agreement in which you pay premiums for a certain time to get guaranteed cover for your monetary losses due to an unfortunate event.  

How does insurance work?

Before you understand how insurance works, it’s crucial to have proper clarity about what is an insurance policy.

The definition: An insurance plan or a policy is a legal contract between the insured (an individual) and the insurer (insurance company). According to it, the insurer agrees to pay the policyholder an assured sum of money in specific situations of suffering to cover the losses, against payment of premiums for a specified period. In addition, some insurance plans aid in growing your wealth too.

The method of functioning: Typically, insurance is a method to financially secure yourself, your family or your property from financial losses occurring due to untoward circumstances. Here, you pay premiums in a defined schedule for a specified period, in exchange for which the insurer is liable to pay you an amount in the event of crisis under pre-set terms and conditions. The insurance company thus pools the money in the form of premiums from all its policyholders to cover one’s losses from an insured event like death, accident, health emergency, theft or damage to vehicle or property.  

Insurance Components

Whether or how insurance will benefit you depends on its components. Thus, understanding insurance is easier when you know these components well. Following are their details.

Insurance premium: An insurance premium is the amount you need to pay for a certain period to get insurance cover. This can be paid in a single time, for a limited period within the policy term or in a regular pay format. The regular pay premiums can be paid in an annual, half-yearly, quarterly or monthly schedule. It is the premium that binds the contract and makes the insurer cover your losses. Usually, higher coverage is available with higher premiums and vice versa. However, the amount of premium is calculated based on certain other factors. For example, the age, gender, health condition, family history, lifestyle and occupational type of the policyholder are determinants of the premium in the case of life or health insurance.   

Policy limit: Policy limit is the maximum compensation or cover the insurer is liable to pay for certain losses. However, this applies to health and general insurance policies only. Life insurances have a pre-defined sum assured payable in case of the policyholder’s death within the policy term.

Deductible: Deductible is also a component specific to general or health insurance only. It is the maximum portion or percentage of money the policyholder pays out of pocket before the insurance company steps in to settle the claim. Here, the insurance company makes a payout only when the loss or expense incurred is greater than the deductible. Thus, the higher the deductible, the lower the corresponding premium for the policy. This happens because bigger out-of-pocket expenses often result in fewer claims.  

Types of Insurance

There are various kinds of insurance available in India to address the risk of unfortunate situations like death, accidents, health emergencies, theft and damage to houses or vehicles due to calamities and accidents. In addition, certain insurances can act like an investment opportunity too.

Going by the meaning of insurance, broadly the policies can be divided into two major categories: Life insurance and General or Non-life insurance. The following table divides various types of insurance plans into these two categories.

Let us now delve deeper into the categories. 

Life Insurance: 

Life insurance is crafted to provide financial protection to the policyholder’s family if he/she dies within the policy term. Here, the sum assured or the life cover amount is paid to the nominee in the event of the unforeseen in the form of death benefit. All the plans under this category have life cover as its primary offering over other benefits. Here’s a glance at these plans.

a. Term insurance: These policies offer only death benefits at a low premium.

b. Endowment policy: An endowment policy provides a life cover as well as an investment component. It offers a fixed and guaranteed maturity benefit after the completion of the policy term.

c. Unit-Linked Insurance Plan (ULIP): The ULIP plan combines the benefits of a life insurance policy and an investment instrument. A part of the premium forms the life cover while the remaining is invested in market-linked funds to fetch returns.

d. Money-back policy: A money-back policy offers regular returns or a lumpsum amount at a defined point of the policy tenure.

e. Savings plan: The savings plan inculcates disciplined savings habits and pays back the accumulated amount upon maturity of the policy.

f. Child plan: Here the nominee is the child, who is entitled to get the sum assured in the event of the policyholder parent’s death so that his/her education or life goals don’t get hindered.

g. Retirement plan: A retirement plan is designed to build a corpus for retirement across the work years and lets you enjoy its benefits as well as fetch a regular stream of income post-retirement.

h. Capital guarantee solution: Here, a part of the premium goes to the life cover. The remaining part is further divided – one portion is invested in fixed-income instruments to secure the capital while the rest in market-linked funds to generate higher returns.

General Insurance:

All the non-life insurance plans fall in this category which covers untoward situations other than death resulting in monetary losses. Following are the types of insurance that fall in this category.

a. Health insurance: Designed to take care of your medical needs, this insurance pays you against hospitalization and treatment charges.

b. Vehicle insurance: These plans cover the costs incurred due to damage to the vehicle by an accident.

c. Fleet insurance: Fleet insurance covers an entire fleet of cars, ships or aircraft under a single policy.

d. House/property insurance: This plan is meant to cover losses or damages to the residential house or any other property.

e. Fire or hazard insurance: This plan financially protects you from losses due to fire or any other hazard.

f. Travel insurance: These policies safeguard your travel experience by making up for your losses due to medical expenses, flight or train cancellation, theft or misplacement of luggage or important documents like passport, license etc. The policy is meant for the time between the arrival and departure of the traveller from his/her base location.

g. Liability insurance: This plan is designed to protect you from claims of damage or injuries to other people or property.

h. Keyman insurance: This is an insurance usually opted for by a company to insure a key person in the organization.