Harnessing the Powers of Insurance as a Key Financial Tool

Life is full of uncertainties and risks. Some hazards can be prevented or at least minimized while some cannot be avoided or anticipated. In almost everything that we do, we face so many risks. None of us can predict what is going to occur in the future. You cannot predict when you might crash your car or come to discover that someone has broken into your home. What we do know is that accidents can happen.

What you can do is protect yourself from potential financial losses when something goes wrong at some point in the future. It is important to know what are the risks involved, the effects of those risks, the potential costs of the risks and the ways to mitigate the risks. This idea is the basis of the insurance industry. We call the protection that we get, insurance.

Basic Principles

• Although the entire insurance process may seem complicated, the basic principles of insurance are very straightforward.
• The insurance company, to a certain degree, assesses the likelihood of an accident or event happening to you and how much would it cost you to put it right.
•  Knowing the risks and potential future costs, the insurance company sets an amount called premium. Often spread over multiple periods, insurance premium is the amount that you are going to pay to protect you against accidents or unforeseeable event.
• If any accident or event that you have yourself protected happens, you then can make a claim to your insurance company and it pays out the agreed amount of coverage.

Common Considerations

 Generally, insurance is a form of risk management in which the insured individual handovers the cost of potential loss to an insurance company. Insurance allows businesses, individuals or other entities to find significant protection against potential losses or financial difficulties. Insurance if often considered for the following:

§  To protect the family against the  potential loss of income resulting from one’s death;

§  To ensure that debts are paid after death;

§  To cover some contingent liabilities;

§  To protect business against the death or key person or employee;

§  To buyout a business partner or co-shareholder in case of death;

§  To protect the business against financial hardships or interruptions;

§  To protect oneself from unforeseen health expenses,

§  To protect homes against unforeseen hazards such as theft, fire and flood, among others;

§  To protect businesses or oneself against lawsuits;

§  To protect oneself in case of accidents and disability; and

§  To protect the vehicle against theft or losses because of accidents.

Insurance Mechanisms

Broadly, insurance works by pooling the risks. This simply means that people who want to be insured against a particular loss will pay premiums to the insurance company to form an insurance bucket or pool. As a large group of people contributes to the pool, insurance companies, through statistical analysis, project the actual losses within a given class. Insurance companies know that not all insured will suffer actual losses at the same time, if at all. 

This allows insurance companies to pay for the claims and at the same time, operate profitably.

Insured individuals are actually paying for the probability of the loss and for the protection that they will receive, upon occurrence of a covered event. For instance, many people have vehicle insurance, but only a few actually figures into an accident. People who have vehicle insurance are primarily paying for the probability that they will get into an accident, and when that specific event happens, they will be paid corresponding to the agreed amount of coverage.

The basic mechanisms of insurance, regardless of the type, include:

§  Insurance Coverage: This refers to the amount of risk or liability covered by the insurance protection availed. In the event of unforeseen or unwanted occurrences, the insurer will pay for the corresponding amount of protection. The amount of insurance coverage depends on multiple factors. Nevertheless, the chance of the insured event to happen actually is the main determinant of the insurance coverage.

§  Insurance Premium: This is the specified amount required to be paid periodically by the insured, under a given insurance policy for a defined period. The premium paid to the insurer is a form of compensation given to the insurer for bearing the risk of payout should the specified events covered happen. Taking the auto insurance as an example, the vehicle owner pays a fixed amount for a definite period. This amount guarantees coverage for any financial losses under the scope of the insurance policy.

§  Insurance Deductible: A deductible is out-of-pocket amount paid when filing a claim. In any type of insurance, the amount of insurance deductible depends on how much the insured party would like to pay out of pocket when filing for a claim. Generally, the insurance premium becomes lower when the insured opt for higher deductibles.

Types of Insurance

There is an assortment of insurance protection for everyone. As long as individuals and business entities have enough cash to pay for the premiums, they can get insurance for almost all things. For most people, the types of insurance policies to consider can be grouped into two:

§  General Insurance: Also known as non-life insurance, general insurance is a form of insurance that is chiefly concerned to give policyholder protection from harm caused by specific perils. Depending on the need level, non-life insurances can be classified whether property and casualty insurance, health and disability insurance or business and commercial insurance.

§  Life Insurance: These policies give financial that offers protection to the policyholders’ dependents a way to replace the loss of income when the insured person dies or is unable to work. Upon the policyholder’s death while the insurance is imposed, the insurance company pays a specified amount of coverage to the beneficiaries. Some life insurance gives policyholders the option to make it a form of savings over the long haul.

Insurance is often a misunderstood financial tool. Nevertheless, it is an integral component of any personal or business financial planning. The amount of coverage and the type of insurance that an individual or business entity will obtain depends on their unique circumstances. When considering an insurance coverage, potential risks and the fiscal impact of these risks must be carefully evaluated. This will help determine the options available and what type of coverage and for what amount. Regardless of the type and amount of coverage, it is essential to evaluate the specific needs to avoid being under-insured or over- insured.