Insurance is the business of providing protection against financial aspects of risk, such as those to property, life and health. The insured makes payments called "premiums" to an insurer, and in return is able to claim a payment from the insurer if the insured suffers some kind of loss. For example, a shipowner could insure a ship, and receive payment if the ship is damaged or destroyed. In the case of a pension the terms 'risk' and 'loss' are somewhat inappropriate, they concern the chances of living at future times and the need for money because of still being alive.
Insurance reduces risk by pooling together a large number of risks. For example, many individual people purchase health insurance[?] policies. They each pay a small monthly or yearly premium to the insurance company, and then when a policy holder gets ill, the insurance company will provide money to cover medical treatment. For some individuals receiving insurance benefits, this may total far more money than they have ever paid into the insurance policy themselves. Others may never make a claim. When averaged out over all of the people buying policies it evens out. Insurance companies set their premiums based on their calculated payouts, aiming to take in more money than they pay out in the long run to cover expenses and make a profit.
An insurance agreement or "policy" will set out in detail the exact circumstances in which a benefit payment will be made and the amount of the premiums.
There are a number of different types of insurance:
A single policy may cover risks in one or more of the above categories. For example, car insurance would typically cover both property (covering the risk of theft or damage to the car) and liability risk (covering legal claims from say, causing an accident).
Potential sources of risk that may give rise to claims are known as perils[?]. Examples or perils might be fire, theft, earthquake, hurricane and many other potential risks. An insurance policy will set out in detail which perils are covered by the policy and which are not.
As well as paying out a sum of money on death, many life insurance contracts also pay out a sum of money after a given time (in which case it is known as an endowment policy), and may also pay out a cash value if the policy is cancelled early. In many countries, such as the US and the UK, tax law provides that the interest on this cash value is not taxable.
This leads to widespread use of life insurance as a tax-efficient method of saving as well as protection in the event of early death. Wealthy individuals buy life insurance policies as a means for avoiding income taxes and estate taxes.
If the tax benefit exceeds the fees charged by the insurance company for maintaining the policy, then the policy serves as an Life insurance tax shelter. There is much controversy surrounding this practice, and the financial industry is deeply divided about whether or not these practices work as advertised.
A lot of policyholders, especially poorer ones, do not understand all the fees included in a policy. As a result, many people buy policies at unfavorable terms. People feel obligated to have some insurance. In many jurisdictions car owners are obligated by law to be insured.
Location is one of the variables used to set rates. This is considered unfair by many. Insurers are also starting to use credit "scores" to set rates.
See also Insurance of terrorism.