Welcome to this complete guide on buying insurance.
In this article, I will share the basic concepts of insurance that are important to understand before purchasing any insurance plan. Please note, I am not an insurance expert. What I share here is based on my personal opinion and limited research. I am not a professional, I am not qualified, and I do not have a license to give insurance advice. So, before taking any action, please consult a qualified expert. Do not rely solely on my words. I may make mistakes, and my goal is only to help through my experiences and research.
What Is Insurance?
Today, we will learn the basics of insurance. Many legal terms are used in the insurance industry, so understanding them is important. For example:
- What is a risk profile?
- What is a premium?
- Why does the premium change?
These are essential to know, no matter what kind of insurance you are buying.
Let’s start with the most basic question—What is insurance?
Insurance is a valuable product. If used properly, it provides you with financial protection. You pay a certain amount to a company—called the insurance company—on a regular basis (annually, half-yearly, quarterly, or monthly) in return for protection.
Protection from what? Protection from something you cannot plan or predict.
The basic idea of insurance is: “If X happens, give me financial protection.”
Here, “X” depends on the type of insurance. For example:
- If you are hospitalized, the insurance company helps pay the hospital bills.
- If you die, your family receives financial support.
This is the core purpose of insurance.
How Does Insurance Work?
Usually, the amount you pay (the premium) is much smaller than the financial coverage you receive. Let me explain this with an example.
I have a health insurance policy with ₹4 lakh coverage for my parents, my sister, and myself. All four of us are covered under one plan. I pay ₹15,000 annually. This means that if any one of us is hospitalized, the insurance company will pay up to ₹4 lakhs in bills. Yet, I only paid ₹15,000 for this protection.
So how is this possible? How can the company offer such a big cover for a small premium?
Basic Terms: Policy, Premium, and Cover
To understand this, we need to understand a few key terms.
- Policy: The contract between you and the insurance company is called a policy. This contract states that if a specific event (like hospitalization or death) occurs, the insurance company will provide financial protection.
- Premium: The amount you pay to the insurance company for this protection. It may be paid monthly, quarterly, half-yearly, or annually.
- Cover: The maximum financial support you are eligible to receive under the policy. For example, if your policy has a ₹4 lakh cover, the insurance company will pay up to ₹4 lakhs for your medical expenses.
Understanding the Business Model
Many people think, “This is a fraud! How can I get ₹4 lakh worth of coverage for just ₹15,000?” That’s why very few people in India have insurance. It feels like paying for something that hasn’t happened and that you hope never happens.
But to understand how this works, let’s look at the business model of insurance companies.
Example:
Suppose there is a town with 100 people, and each person buys health insurance worth ₹2 lakhs. Everyone pays ₹10,000 annually. The total money collected by the insurance company is ₹10,000 × 100 = ₹10,00,000.
Now, based on their data, the company predicts that only 2% of people (2 out of 100) will be hospitalized in a year. Even if the full ₹2 lakhs is paid out for each of those 2 people, the total expense is ₹4 lakhs. The company still keeps ₹6 lakhs, not counting other expenses.
This is how they make money—through risk pooling.
What Is Risk Pooling?
Insurance companies group people into categories based on similar risks. This is called risk pooling. For example, in health insurance, if you smoke but are otherwise healthy, you may be grouped with others who smoke but are otherwise healthy. The company assumes that the risk for this group is similar.
Based on these risk profiles, companies set premiums. That’s why premiums vary depending on your age, medical history, and lifestyle.
Why Premiums Vary
Since I bought health insurance at the age of 21, I received a lower premium. If I had waited until I was 40, the premium would have been higher for the same cover. Why? Because the risk of hospitalization or death increases with age.
Insurance companies consider many factors when deciding the premium:
- Age
- Health conditions
- Lifestyle habits
- Location
- Type of coverage
In more developed countries like the U.S., even more data is used. For example, when buying car insurance, they consider:
- Your driving history
- The area you live in
- Daily travel distance
- Vehicle type
If you are young, drive a fast car, and have had accidents, your risk profile is higher. Compared to someone older, who drives a small car and has never had an accident, your insurance premium will be higher.
Final Thoughts
Understanding the fundamentals of insurance—**what it is, how it works, what a policy means, what a premium is, what cover you get, and how pricing is determined**—is essential before purchasing any insurance product. Whether it’s life insurance, health insurance, car insurance, or insurance for a home loan, this foundational knowledge will help you make an informed decision.
This article is intended to be a starting point in your insurance journey. If you have questions or need clarification, I encourage you to consult a certified insurance advisor.
Thank you for reading. If you found this helpful or have questions about insurance, feel free to leave a comment.
