What Is Insurance and Why Do You Need It?

Insurance can often be a complicated topic for many, filled with contract and legal jargon that is hard to decipher. But at its core, it's about Risk.

How much of the risk are you willing to keep for yourself, and how much of the risk can you transfer to someone else. That term, "Risk Transfer" is the backbone of what insurance is all about. It is simply paying an amount of money, known as a premium, to a third party to take on the risk for you. This premium is generally a relatively small amount compared to the maximum amount of coverage you are buying. These smaller premiums are accomplished through "pooling" large number of people together who all pay premiums into one large bucket.

There are two main reasons someone seeks insurance

Now that we have a little background on what insurance is, why do you need it? There are two main reasons someone seeks insurance; 1. It's required by someone or something else, 2. You want to protect your financial assets. If it is required, you might hear it called "compulsory". An example of a compulsory policy is personal auto insurance. Every state in the U.S. require drivers to carry auto insurance to protect other people from injury or property damage. You are responsible for your actions and the law says you must compensate others for their loss. This is called third party liability. Each state sets its own rules, but essentially there is a minimum amount of coverage every driver most carry.

Private contracts

Governments are not the only entities that can require insurance. Private contracts often dictate that one or both parties involved have forms of insurance that are relevant to the transaction. For most people, the most common form they experience this from is their mortgage or lease. Lenders want to give you a big pile of money to go purchase a home or car, and they make interest along the way as you pay off the loan. But what happens if the property gets destroyed between when you bought the home or car, and the time you made your last payment? Well, the bank or mortgage company wants to make sure you don't just walk away. Part of the way they do this is to require you to transfer the risk by purchasing an insurance policy. That policy covers against physical damage to the thing they gave you money to buy. If you crash your new car, or your home burns down, the lender wants it replaced since they have a financial interest. Insurance allows all of us to take the financial risks in life to better our economic position.

After you pay off that loan, and you have satisfied the government with the minimum amount of liability insurance, why would you still need an insurance policy? One word, Protection. You worked hard your entire life to get to where you are now. And most likely your home is your largest personal asset. Do you have enough money in the bank to replace it? Your family home is important to you and you love your car and your boat and you have worked hard for your valuable possessions, (that nice set of golf clubs is expensive and so was 3 Carat diamond ring your husband gave you on your 20th wedding anniversary that you so rightly deserved. Sure, insurance can be purchased to protect against physical damage like a fire, or if a tree falls through your house, but what about if you seriously hurt someone? Higher limits of coverage are available for a little more premium to protect against judgements levied against you. This transfers risk away from your financial assets and helps to prevent seizure and docking of future income.

Life & Health Insurance

The last major category of insurance is Life & Health Insurance. And while they are often grouped together, they do two different things. With health insurance you pay monthly premiums to cover medical costs for yourself or your family. Doctor and hospital visits can be very expensive and is one of the leading causes of bankruptcy in the United States.

Life insurance protects your family or other some other persons or entity against the loss of future income. It is the security blanket put in place that says if you pass away, there will be money to pay the bills after you are gone. Example: If the bread winner in your family were to suddenly pass away, how would you pay the mortgage? Would be able to send your kids to school? Would you be able to afford your current life style? People insure things that are replaceable, but they won't insure their family. Life insurance provides peace of mind, financial stability, and a future for your loved ones. So how do you know which policies you need, the right limits to buy and if you are paying the correct premium? It is a difficult question to answer but working with a professional risk manager and a financial advisor is a good place to start. Your trusted team can you help make the right choices regarding insurance and allow you to sleep a little easier at night.