An insurance is a legal agreement between an insurer (insurance company) and an insured (individual), in which an insured receives financial protection from an insurer for the losses he may suffer under specific circumstances.
Under an insurance policy, the insured needs to pay regular amount of premiums to the insurer. The insurer pays a predetermined sum assured to the insured if an unfortunate event occurs, such as death of the life insured, or damage to the insured or his property.
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Insurance - Meaning and Definition
The literal meaning of insurance would be an assurance against unforeseen and unfortunate loss. This means, that if you encounter a less than normal event in your normal course of life, and happen to incur a financial loss because of it, you can be compensated.
For example, you met with an accident on your way to the office in your car and the car suffers damage. Your insurer can reimburse the repair expenses in this case. However, the insurer will not reimburse normal wear and tear like a headlamp stopped working.
Legally insurance has been defined as a contract where the insurer agrees to compensate the insured against the losses incurred due to any unforeseen contingency. The contract also involves a consideration which is called a premium. The maximum available benefit amount is called sum assured or sum insured.
How does an Insurance Policy Work?
To understand how insurance works, you should know below terms:
1. Premium:is the money you pay to the insurance company to avail of insurance policy benefits.
2. Sum Insured:Sum insured is applicable for a non-life insurance policy like home and health insurance. It refers to the maximum cap on the costs you are covered for in a year against any unfortunate event.
3. Sum Assured:Sum assured is the amount the life insurance company pays to the nominee if the insured event happens (death of insured).
As discussed above, insurance is a legal contract between the insurer and the insured. The insurance policy lists all the policy's conditions and circumstances under which the insurance company is liable to pay you or the nominee the insurance amount.
When you buy an insurance policy from the insurance company, you will have to make regular payments (premium) for a specified period towards the insurance policy.
The insurance company collects the premium from all the clients. They pool the money for losses that may arise out of an insured event. If you don't claim during the policy tenure, you may or may not receive any benefits. It depends on the policy type and the conditions.
Also Read - Different types of insurance policies
An insurance policy is made of multiple components. Some of the important parts of an insurance contract are:
a) PremiumThis is the financial consideration which makes the insurance agreement a legally binding contract.
b) Policy LimitPolicy limit applies to health and general insurance policies where compensation depends on the amount of loss. The policy may limit the maximum compensation for certain types of losses.
c) DeductibleDeductible applies to general insurance and health insurance policies. A deductible is the maximum amount of loss you will bear out of your pocket. The insurer will start paying only when your losses (or expenses) rise above the deductible limit.
Insurance contract has been classified into two categories traditionally. These classifications are based on insurance principles:
|Life Insurance||General Insurance|
|- Term Life Insurance||- Health Insurance (Mediclaim) plans|
|- Endowment Life Insurance||- Vehicle Insurance|
|- Moneyback Plans||- Fleet Insurance|
|- Savings Plans||- Home/Property Insurance|
|- Child Education Plans||- Fire & Hazards Insurance|
|- Unit Linked Insurance Plans (ULIPs)||- Travel Insurance|
|- Liability Insurance|
|- Keyman Insurance|
Types of Insurance Policies
You can divide the insurance based on the type of coverage it is providing as below:
1. Life Insurance Policy
It is insurance on your life. You buy life insurance to ensure that your loved ones are financially secured even when you are not around. If you are the only breadwinner, you would want your family members to maintain the same living standards in the event of your untimely demise. The nominee gets the sum assured in case of your death.
Must Read - What is Life Insurance?
2. Health Insurance Policy
Although health insurance is usually counted as a general insurance contract, there are a few differences. Health insurance covers your medical costs for expensive treatments. You can avail two types of health insurance policies:
- Mediclaim Insurance, which compensates you for the medical expenses
- Critical Health Insurance, which offers lump-sum payments for dangerous and life-threatening health conditions
Because of these two variants health insurance falls perfectly between general and life insurance policies. Also, both health insurance policies are important in ensuring complete financial safety for you and your family.
Learn whether you should opt for a long-term or short-term health insurance policy.
3. Non-life Insurance Policy
These compensate you for the losses sustained arising from a specific financial event that is not related to life. Non-life insurance could be car insurance, home insurance, etc.
You can avail insurance benefits under the following two types of policies:
|Individual Insurance||Group Insurance|
Key Features of Insurance
Key insurance features which make insurance plans from all other financial instruments and investments are:
i. Insurance is a tool for risk transfer.
ii. Insurance is a community solution as several people, who are exposed to the same risk, pool their funds together to bear the loss.
iii. The contract is based on the ‘utmost good faith’ principle unlike other business contracts.
iv. Insurance cover does not affect the chance of loss or minimise the magnitude of loss.
v. As a party to the insurance contract, you should always try to avoid, mitigate and minimize the losses.
vi. You can only insure against risks which are unpredictable in occurrence and magnitude.
vii. Speculative, financial (betting) and business risks cannot be insured.
Benefits of Insurance
You must have insurance for the below reasons:
1. Financial Safety for Family:They provide cover against life's uncertainties and protect you against losses arising from different unexpected events in life.
2. Safety of Financial Status:Certain events like medical emergencies can have a significant impact on your cash flow management. Insurance ensures you don't have to pay out of pocket for such situations.
3. Wealth Creation Goals:Insurance policies like ULIPs give you investment opportunities and help you fulfil your essential financial goals.
4. Wealth Preservation:Life insurance policies like endowment and moneyback plans are some of the safest long-term investments possible. These plans help you preserve your wealth from inflation and taxes for long periods.
5. Wealth Distribution:Few investment plans offer the kind of safety offered by life insurance pension plans. After retiring at the age of 60, you can live up to 100. Only life insurance pension plans can guarantee a regular income for that period.
Two Life Insurance Policies you Must Have
You must know the importance of insurance in your life, and once you understand it, you must have below insurance policies:
1. Term Insurance Plan:
This is the purest form of life insurance wherein you pay a premium towards the policy, and in case of your death during the policy tenure, the nominee receives the sum assured. With term insurance, you can receive high coverage against a lower premium. iSelect Smart360 Term Plan by Canara HSBC Bank of Commerce Life Insurance offers critical illness cover against 40 listed illnesses.
2. Health Insurance Plan:Knowing the rising cost of healthcare and the number of diseases you can have, it is wise to have a financial cushion against health contingencies.
Knowing the rising cost of healthcare and the number of diseases you can have, it is wise to have a financial cushion against health contingencies.
3. Motor Insurance:These are mandatory legal requirements in India, and you must have them if you own a two-wheeler or a four-wheeler. It is compulsory to avail of third-party liability motor insurance. However, you can have a comprehensive package to get covered against the various risks of damage with the personal accidental cover.
4. Home Insurance:Your home is exposed to various kinds of risk like theft, damage due to natural calamity, etc. Hence to protect your home against such damages, you must avail of home insurance.
Such insurance plans will help you stay afloat even after a costly mishap or calamity.
Tax Benefits of Insurance
Insurance gives your safety and security benefits and also income tax benefits. The benefits are as follows:
a) You can claim a life insurance premium of up to Rs 1.5 lakh under Section 80C.
b) Under Section 80D, you can claim a medical insurance premium of up to Rs 25,000 for self and family and additional Rs 25,000 for parents. The deduction limit rises to Rs 50,000 if the insured are senior citizens.
c) Under Section 10(10D), the life insurance benefits you or the nominee receives from the insurance company are tax-exempted. This means both maturity value and death benefit received from a life insurance policy will be tax-free.
However, the maturity benefit is tax-free only if your annual premium for the policy does not exceed 10% of the base life cover in the policy.
Also Learn - importance of insurance
FAQs Related to Insurance Policy
There are two types of insurance needs – long-term and short-term. Short-term needs are usually for less than one year to up to 3 years. Long-term insurance needs can last for a lifetime. Long-term insurance needs such as life insurance and health cover needs are usually permanent.
However, insurance needs such as car insurance, travel insurance, etc. would be there for a limited period only.
The technical difference is that one of the key principles of insurance, the ‘principle of indemnity,’ does not apply to life insurance policies. This principle says that the compensation from insurance can never exceed the magnitude of loss. However, in the cases of death magnitude of loss is unclear.
Thus, the benefit would be limited to certain times the annual income. Generally, insurers limit the benefit to 20 times, however, it can go up if your financial health is better.
For life insurance policies you can only file one claim per incident. For example, if your life insurance policy covers total and permanent disability you can file a claim for it only once. Even though your life cover will continue after this, the insurer will not entertain another disability claim on the same policy.
With general insurance policies, however, you can continue to file claims until your sum insured is completely exhausted. For example, family health insurance of Rs 5 lakhs will entertain hospital bills for any covered family member until the reimbursements reach the limit of 5 lakh.
A cashless facility is available with motor, travel and health insurance. The cashless facility shortens the process of claiming refunds from the insurer after incurring the expenses. It allows you to avail the treatment, and repair of the vehicle without having to indulge in the paperwork. A cashless facility is quite useful as you may not always have ready cash in the case of an emergency.