Insurance

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With insurance you pay to be protected from specially defined financial loss, as described in a written policy document.

So you pay them every year (or month and so on), and if something bad happens then they pay you a large sum of money!

But the policy document will have many rules saying under what conditions they will or won't pay, and how much they will pay. It can be very long and should be read carefully.

Key Terms

Premium: The amount we pay (monthly or yearly) to have the insurance
Deductible: The "out-of-pocket" amount we must pay ourselves before the insurance company pays the rest

Two hands holding a paper house under a protective umbrella

Example: Homeowners' Insurance

You pay them $2,000 a year (the premium), and if your house is damaged they will pay to have it fixed.

But you must pay the first $1,000 (the deductible).

A storm causes $10,000 in damage to your roof. You pay $1,000 and the insurance company pays $9,000.

But rules might include "like for like replacement" (they won't pay for upgrades) or "not due to flooding" (if you are in a flood prone area) that protect them from certain payouts.

Major types of insurance include:

Health: Covers some medical costs if you need them, such as hospital costs
Liability: Protects you from others’ claims of loss due to your negligence or improper actions Note: This is often legally required for car owners and many businesses.
Auto: Covers theft, accidents, and damage to others. Most places require at least liability coverage to drive legally
Homeowners: Protects your property and personal belongings from fire, theft, or storms (with conditions)
Disability: Replaces part of your income lost if you can't work because of illness or injury
Long-term care: Covers specific costs of care in a nursing facility or at home
Life: Gives money to your dependents if you die. Special rules apply

How Does it Work?

Imagine 100 people each put $10 into a box. Now there's $1,000 in the box. If one person has a $900 accident, the box can pay for it! We all shared the risk.

What to Insure

Insure what you can't afford not to insure.

Does that sound weird? Maybe some examples will help:

You can afford bread, so no need to insure that!
You can afford a new microwave, so no need to insure that, either
But you can't afford to replace your car, so do insure it

So think about the really costly things that might happen, and insure against those.

Example: Your Car is Really Cheap

So you can easily repair or replace it with a similar one.

So no need to insure it, right?

Small blue compact car

But what if your car damages a Mercedes and they want $20,000 in repairs?

That's Liability Insurance, so maybe you need to look at that.

Insurance is about peace of mind. By sharing risk with many other people, it can save you from bad situations. But make sure to understand what you are paying for.