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Basics of Insurance

What Is Insurance?

Insurance is a contract in which one party indemnifies another party against loss from a specified future event or contingency in return for the payment of a premium.

An insurer is company that provides, or issues, an insurance policy to a person or company. An insurance policy is a document containing the terms and conditions of an insurance contract and the applicable coverage. Insurance is a contract between an insurer and a person or company who is insurable—that is, the person or company that could collect money if a certain harm or loss happened. The person or company pays a premium, a specified amount of money paid each month to an insurance company to remain insured, meaning they are covered under an applicable policy issued by an insurer. In return, the insurer agrees to indemnify the insured person or company, which means they are protected from the risk of that specific type of loss in the future. Risk is a key component of insurance, as it is the uncertainty about a loss against which an insurance policy provides coverage.

For example, if Trent buys a vehicle, almost every state requires him to buy insurance for the vehicle. Depending on the state, Trent might have to buy liability insurance, which protects him from having to pay damages if he gets into an accident and a court finds that he was at fault. He might have to buy property insurance, which is a policy issued by an insurance company that protects against fire, theft, or weather damage to structures and the items within them. In this case, it would pay for any repairs needed to others' vehicles if Trent gets in an accident. He might also have to buy personal injury protection coverage to cover doctor bills or lost wages if he or a passenger is injured in an accident. Trent might need uninsured or underinsured motorist coverage, in case someone with little or no insurance damages his car or injures him in an accident.

To secure coverage—that is, the amount of insurance protection that an insurer provides—Trent needs to pay his monthly premium promptly. If he does not pay on time, the insurance company may cancel the policy, resulting in a lapse of coverage, a period of time during which there is no insurance. If an accident happens while there is a lapse in coverage or no insurance coverage, then the person or party at fault might have to personally pay for any damages resulting from the accident. For this reason, it is vital for business leaders to have the necessary insurance and to understand the coverage under the applicable policy in the event that the business needs to make a claim.

How Businesses Use Insurance to Help Control Risk

Although the process of insuring a business can be complex, just one significant payout from an insurer can save that business from financial ruin.
Most insurance contracts are adhesion contracts. In an adhesion contract, the insurer has the negotiating power, and the insured must sign or seek services elsewhere. In other words, the insurer sets the terms, and the person or business either accepts them or looks elsewhere for coverage.

Failure to disclose any material facts can result in a denial of coverage. A material fact is a piece of information that an reasonable person would recognize as important or relevant to a decision. For example, if Trent lied to his car insurer about his previous history of car accidents, that would be concealing material facts.

Who May Get Insurance?

Insurance lets people absorb potentially large and immediate costs from business interruptions or accidents without financial hardship or bankruptcy. People with an insurable interest in a property can buy insurance to lessen the risks of ownership.
People with insurance coverage are able to pay significant costs from accidents without facing financial ruin.
Business owners often struggle with whether or how to subsidize employees' health insurance. Health care coverage provides significant advantages to employees and employers by helping to ensure a healthier workforce. Offering insurance helps a company recruit and retain employees.
People with an insurable interest in a property can buy insurance on that property. An insurable interest is one where the person would be harmed by the danger that he or she has insured against.

For example, if Violet bought car insurance for her vehicle, she would hopefully be less likely to intentionally crash it. First, an intentional act would likely not be covered. Second, it would be illogical for Violet to crash her own vehicle, as it is this vehicle that she is paying to insure. However, if Ethan bought automobile insurance for Violet's car, he would probably be happy to collect the insurance proceeds if her vehicle were wrecked. Because it is not Ethan's vehicle, he can only benefit financially if Violet's car is destroyed. Insurers insist on insurable interest to make fraud and other crimes less likely.

In addition, the insurable interest can be no greater than the actual amount of the loss that the person or business suffers. In other words, if Violet bought automotive insurance for $50,000 and her car is worth only $10,000, her recovery for the damage or loss of her car would be limited to $10,000.

Other types of insurable interests include life insurance on one's own life or the life of a spouse or other family member. Life insurance provides benefits to the beneficiary in the event of the death of the insured party. Spouses often buy life insurance on one another because their finances are interdependent. Certain types of business relationships are also insurable. For instance, if Selena and Tom are partners in a business, they may each insure the other's life. If one of them dies, then the money from the life insurer would go to the partner who would then have enough money to continue to run the company. A business can also buy separate life insurance policies for the partners of the business. The business is then the beneficiary of the policies. If a partner passes away, the business can use the death benefit to purchase the deceased partner's share, for example.

Other types of business insurance include key employee insurance, life insurance on the key person in a business; business interruption insurance for when disaster strikes; errors and omissions insurance for actions taken by boards of directors; and malpractice insurance to cover professional mistakes that harm clients.