What is Insurance?

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Insurance is a contractual agreement between two parties where one party agrees to protect the other from financial loss.

🤔 Understanding insurance

Insurance is a contract in which one part protects another from financial loss. Different types of insurance policies protect people in different aspects of their lives. Common types of insurance include health, life, car, and homeowner’s insurance. Most insurance policies require that an individual pay a (typically)monthly premium to an insurance company. Then, in the event of financial loss, the insurance company will protect or reimburse the policyholder. Insurance policies help people to repair damage to their person or property and also cover liability from damage to someone else’s person or property.


Suppose Sandra just bought a new car. The first thing Sandra did after buying her car was to purchase an insurance policy, which requires that she pay a premium every month for her insurance coverage. A few months later, Sandra gets into a car accident. Because she has an insurance policy that covered accidents, the insurance company pays for her car repairs.


Insurance is like an emergency fund…

Every month, you put money into the emergency fund. Then, if something goes wrong, the fund is there to help you out financially. Similarly, you pay an insurance premium every month. Then, if disaster strikes, you’ve got insurance to help protect you from financial loss.

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How does insurance work?

Most people living in the United States have at least one or two different insurance policies, whether it be health, auto, life, or homeowner’s insurance. Each insurance agreement covers you for a specific period. You pay for the policy in the form of a monthly, annual, or biannual premium, and in return, the insurance company helps protect you from certain financial losses.

Each insurance policy has at least two parties: the person buying the insurance policy and the insurance company selling the policy. An insurance company is a business whose model is selling insurance policies and making a profit off those individuals who don’t have to use their coverage — or, at least, use it for an amount significantly lower than they’ve paid in premiums. So an auto insurance company, for example, is banking on the fact that you’ll pay for an insurance policy all the time but will rarely get into a car accident.

All of the company’s clients, taken together, constitute a risk pool — meaning the company will profit if it charges its pool of customers more than they collectively end up being reimbursed in claims. The insurance can still be worthwhile to each individual customer, since the customer is buying the protection and peace of mind that they won’t have their wallet drained unexpectedly by a stroke of bad luck.

Some insurance companies sell one specific type of insurance, while others sell many different types of insurance.

What are the main types of insurance?

Health insurance

Health insurance is a contractual agreement where you pay a monthly premium to a health insurance company, and they promise to help pay your medical bills. Most health insurance plans cover preventative care visits and provide a certain amount of coverage for other medical care and prescriptions.

Many employees receive a health insurance policy as a benefit from their employer — The employer usually agrees to pay some or all of the premium. There are also insurance plans available to those who can’t get insurance through an employer. Medicaid provides health insurance coverage to those with low incomes. The Affordable Care Act offers subsidies to help make buying health insurance on the government marketplace more affordable.

Auto insurance

Auto insurance is a policy that car owners purchase to help lower their costs if they’re in a car accident. Car insurance policies offer coverage for liability in case you damage someone else’s car, and they often provide collision coverage to help you repair your own vehicle.

Car insurance policies sometimes run on a six or 12-month basis. You can pay your premium in one lump-sum once or twice per year, or you can pay monthly. Most states in the U.S. require that all drivers have some basic level of liability insurance in case you cause an accident. This liability coverage pays for repairs for someone else’s vehicle, as well as medical bills in case another driver sustains injuries in the accident.

Homeowner's or renter's insurance

Homeowner’s insurance is a type of property insurance that helps to pay for damage to your home and possessions in your home. This type of insurance covers structural damage to your home. So if a tree falls on your roof, your homeowner’s insurance will help to cover it. These policies also cover the items in your home. If there’s a fire, your homeowner’s insurance may cover the damage to your home as well as pay for you to replace the belongings that you lost in the fire. Coverage varies across different policies.

Similar to homeowner’s insurance is renter’s insurance. The difference is that renter’s insurance doesn’t cover damage to the actual building — That’s up to your landlord. These insurance policies only cover your possessions in the home and often some liability coverage.

Life insurance

Life insurance is a policy where an insurance company agrees to give money to your beneficiaries if you die. When you buy a life insurance policy, you have to decide who your beneficiary is. It’s usually your immediate family, like a spouse or children. You also need to decide between term life insurance (which sets a specific benefit amount during a set term) and whole life insurance (which remains in force for your entire life, so long as the premiums are paid).

Umbrella insurance

Umbrella insurance is a type of catch-all insurance that supplements your other insurance policies. Umbrella insurance kicks in if your liability goes above and beyond what your other policies will pay. So if you file a claim on your homeowner’s or auto insurance that exceeds the policy limit, your umbrella insurance may pay for it.

What is an insurance policy?

An insurance policy is a contract between you and your insurance company. The insurance policy contains important information about your agreement, such as the premium, the deductible, the copay, and what types of damage and liability your insurance company will cover.


Every insurance policy includes a premium. The premium is the cost of the insurance policy. You usually pay this on a monthly, annual, or biannual basis. Your premium will vary based on the amount of coverage your plan includes, the size of your deductible, and your history.

As a general rule, your premium will go up as the amount of coverage you want goes up. Additionally, lower-deductible plans usually include higher premiums. Finally, certain people can expect to pay more than others — Someone with a poor driving history full of speeding tickets and car accidents, for example, will probably pay a higher premium for auto insurance than someone who has a clean driving record.


A deductible is the amount of money that you’ll have to pay out of pocket before insurance coverage kicks in. Most types of insurance policy will feature some sort of deductible. For some plans, deductibles might be as low as $500, while some health insurance policies might have deductibles of thousands of dollars.

Imagine that you’re in a car accident. Yours was the only car involved, and there were no injuries, but your car needs some repairs. You have collision insurance, so you file a claim with your car insurance company. Because you have a deductible of $500, your insurance company covers the cost of the damage to your car, minus $500.

Some insurance policies have a per-claim deductible. If your auto insurance policy had this type of deductible and you were in another accident later in the year, you’d have to pay a second deductible.

Other insurance policies, usually health insurance policies, have an annual deductible. So once you have met your deductible for the year, your insurance will apply — You don’t have to pay a separate deductible each time you visit the doctor.


A copay (short for copayment) is a feature of many health insurance policies. It’s the amount your insurance company requires that you pay out of pocket for each visit to the doctor. This amount is usually a reasonably low flat amount, between $15-$25. Your copay will vary based on what type of insurance plan you have (such as a health maintenance organization or a preferred provider organization).

Let’s say you schedule an appointment with your primary care provider. Your insurance company covers preventative care appointments, but they require that you pay a copay. So when you get to the doctor’s office, you’ll have to pay a small amount.

The copay is separate from the deductible. So even if you pay enough out of pocket to meet your deductible for the year, you’ll still have to continue to pay your copay at each appointment. The only time you’ll no longer have to pay a copay is if you meet your out-of-pocket maximum, which is a feature in some health insurance policies that specifies the most you’ll ever have to pay out-of-pocket in one year.

Policy limit

For most insurance policies, the insurance company will only provide coverage up to a certain amount. The maximum amount they will pay for is a coverage limit. Some insurance policies will have multiple coverage limits that apply to the different types of coverage provided in the policy.

For example, take a look at your auto insurance policy. You’ll notice that your plan may have more than one type of coverage. First, you’ll likely have coverage for liability. If you’re at-fault in an accident, your liability coverage will pay for other people’s medical expenses and car repairs, but only up to a specific limit. You might also have collision coverage, which means that your insurance company will pay for repairs on your vehicle — But again, they only cover up to whatever the limit is on the policy.

Previously, many health insurance policies also include lifetime limits, meaning the maximum that an insurance company would cover over your life. Once you met your lifetime limit, your insurance company would no longer pay for medical care under the policy. These lifetime caps are no longer legal. The Affordable Care Act, however, prohibits insurance companies from implementing these caps.

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The free stock offer is available to new users only, subject to the terms and conditions at rbnhd.co/freestock. Free stock chosen randomly from the program’s inventory. Securities trading is offered through Robinhood Financial LLC.


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