Insurance is a contract (policy) in which an individual or entity receives financial protection or reimbursement against losses from an insurance company. The company pools clients’ risks to make payments more affordable for the insured.

Insurance policies are used to hedge against the risk of financial losses, both big and small, that may result from damage to the insured or her property, or from liability for damage or injury caused to a third party.

Because insurance also involves spreading the risks of a few among many, some premiums may be wasted on those who never need to file a claim. This is known as adverse selection.

To counteract adverse selection, insurance companies have developed underwriting (which considers an individual’s medical history and other factors) and have created different types of policies for different kinds of risk. For example, some companies offer separate policies for people who own homes, cars and boats.

Understanding Insurance

Insurance is a way of protecting yourself against unexpected costs. It can help you to recover from loss or damage to your property, possessions, health, or income.

Health insurance will pay for some or all of the cost of treatment for illness or injury. Health insurance usually pays out regular amounts if you become ill and cannot work, too.

Insurance companies collect premiums from their customers – the people and businesses that are insured. They use these premiums to pay for claims made by their policyholders (the people and businesses who have insurance), plus their own costs and profit.

Because insurance is a necessary part of life. You’re required by law to have auto insurance and health insurance, and you need homeowners’ or renters’ insurance to protect your home. If you have a mortgage on your house, your lender will also require you to have home insurance.

Protect yourself from financial loss

Personal finance experts often recommend having an emergency fund equal to six months’ worth of expenses. That amount can be hard to save up, especially if you’re already trying to pay down debt or save for retirement. Insurance helps protect you against potentially devastating financial losses due to things like accidents or disasters that may be out of your control. For example, imagine what would happen if you were injured in an accident and couldn’t work for a couple of months. If you’re like most people, your emergency fund wouldn’t stretch far enough to cover all of your living expenses for that length of time. Disability insurance could help make up the difference so you don’t risk losing your home or falling behind on bills while you recover.

Satisfy legal requirements

Laws in most states require drivers to have auto liability insurance at the very minimum, and many lenders require homeowners carrying a mortgage to have homeowner’s insurance as well. The more coverage you carry beyond those minimum requirements, the better.

Why do I need insurance?

Insurance is a way of managing risk. Although you hope you will never need it, the right insurance can help protect you and your family from financial hardship when the unexpected happens. It can also be an important tool for building wealth.

Insurance can provide people with security, protection, and peace of mind. It is a risk management tool that transfers the cost of potential losses to an insurer in exchange for regular payments called premiums.

The insurer then pools the premiums from many policyholders to pay for claims as they arise.

Insurance can help manage financial risk by pooling resources to reduce the impact of losses on individuals or businesses and providing funds for future losses that are uncertain in timing and amount.

You can’t predict the future. Something bad could happen to you or your staff at any time. You never know when you’ll need money to help pay for medical bills, property damage, legal fees, and other unexpected expenses.

Insurance helps you recover from losses. It protects you financially if something bad happens, like a car accident, flood, or fire. It also protects you if someone sues you or if you’re legally responsible for someone else’s injuries or property damage.

Insurance is a way of managing risk. It can prevent you from having to pay very large bills all at once if something unfortunate happens to something you own, like your house, your car or yourself.

If you have insurance, the insurance company pays some or all of the costs that you’re insured against.

What type of insurance do I need?

There’s no one right answer to this question, as the type of insurance you need will depend on a number of factors — your job, your health, your family situation, and more. But you should always consider insurance coverage in several areas.

Health insurance: Getting sick or injured can be incredibly expensive; even a short hospital stay can cost tens of thousands of dollars. Health insurance gives you access to doctors, hospitals, and other medical services for a much lower cost.

Life insurance: No one likes to think about his or her own mortality, but life insurance is an important way to protect loved ones financially when you’re no longer around. Life insurance can pay for funeral costs and help provide for children or other dependents.

Disability insurance: Disability insurance replaces part of your income if you become disabled and are unable to work. It’s important because even if you have significant savings or investments, it’s hard to maintain your standard of living without a steady paycheck.

Homeowners or renters insurance: If your home is damaged in a fire or storm, homeowners/renters insurance covers the cost of repairs and helps replace damaged possessions. It also protects you from liability if someone else is hurt at your property.

Auto insurance covers your car — and much more. It protects you from financial loss in the event of an accident as well as from liability for injuries to others or property damage that result from an accident. It also covers expenses if your car is stolen or damaged by fire, flood, or some other cause.

If you find yourself in need of any of the insurance plans listed above, consider shopping around and asking a lot of questions. Make sure the agent thoroughly explains coverage options and rates before you sign a contract. Get all the information you can beforehand so that you can make an informed decision. Keep your insurance needs in mind when you shop around for a financial plan. Shop lenders based on which ones offer the best insurance solutions. The right mortgage and life insurance provider can save you money big-time on your monthly payments.