Insurance 101: Definition, Components and Benefits

Simply put, the definition of insurance is a contract between an individual (known as the “policyholder”) and an insurance company. In this contract, the insurance company, or carrier, agrees to provide the insured individual (or individuals) named on the policy with a certain amount of financial reimbursement after a covered loss. The insured's reimbursement amount will depend on their policy’s terms, coverage limits and more.

Insurance can help you safeguard your assets in many different areas and help protect your property, family, business and even your reputation. Having an insurance policy can help you recover after what would’ve otherwise been a huge financial loss.

Insurance can allow you to rebuild the destroyed property, replace stolen property, pay for lawsuit costs and much more. Only the disasters or “perils” listed on your insurance policy will be eligible for reimbursement from a claim. Learn more about how insurance works, some key terminology, commonly purchased policies and our experts' insights on what to look for in an insurance company.

Your insurance coverage will be active for as long as your policy is in effect, which is often referred to as the policy term. With your contract’s term, if you endure a loss that’s listed on your policy, you can file a claim with your insurance company to request reimbursement.

For example, the insurance company would investigate your claim if you experienced a fire in your home that destroyed your couch, half of your living room and its contents. The investigation often involves sending an adjuster to visit your property and assess the damage and incident in person. Depending on your insurance company’s decision, you may receive reimbursement for your claim, which could help you replace your couch and other items and get the damage to your living room repaired.

Before being reimbursed, however, you'd first pay your policy's deductible amount — which may be a percentage of the total value of what you're insuring or a specific dollar amount, such as $500 — out of your pocket. You're responsible for covering the deductible for each claim you make.

The reimbursement you receive for a successful claim depends on your policy’s coverage limits. Each category of your coverage, such as property or dwelling, comes with its limit for the maximum amount of reimbursement you can receive after a disaster. If the damage to your property (or other) exceeds your policy's coverage limits, you may have to cover the remainder of the damage out of your pocket.

Insurance comes with a lot of jargon, and understanding its technical language can help you better understand your coverage and what’s included in your policy. Familiarize yourself with the following definitions of standard insurance terms like deductible, premium and exclusions, so you won’t be left scratching your head when reviewing your policy or trying to file a claim.

The primary benefit of insurance is to reduce financial risk. You can buy an insurance policy to mitigate risk in just about any category you can imagine. Here are just a few common forms of insurance and how they benefit the insured.

Though insurance is available for almost anything under the sun, certain types of coverage are more popular than others. Common areas where people buy insurance are for their homes or other property, cars, special vehicles, assets (life), health and medical expenses and pets. Here's a quick look at how some of the most common types of insurance function and who benefits from them.

Home Insurance

Home insurance offers reimbursement after damage to your property. This coverage is purchased by folks who own their homes outright. Home insurance covers many threats to your home and personal property, such as fire damage, lightning strikes, vandalism, falling objects, snow damage, certain types of water damage and much more. Home insurance typically covers your home’s structure (also called the “dwelling”), your personal property like clothing and electronics, your personal liability if you injure a third party or damage a third party’s property and additional living expenses if you must stay at a hotel or other temporary residence while your home is under repair for a covered disaster. This coverage is often made mandatory by mortgage lenders.

Auto Insurance

Car insurance offers reimbursement for accidents or other types of vehicle-related incidents, depending on the types of coverage you select. At least some car insurance is required in every state, but the exact required coverages vary by location. Anyone who owns a vehicle is required by state law to at least buy the minimum mandatory coverage. This can include property damage liability, bodily injury liability, uninsured motorist coverage (that covers your losses if you get into an accident with an uninsured driver), personal injury protection (that covers your injuries or injuries to your passengers in an accident that you caused) and more. Car insurance can protect your vehicle against physical damage and protect you against lawsuits if you cause an accident or injure someone else with your car.

Motorcycle Insurance

Motorcycle insurance works very similarly to car insurance. However, the minimum motorcycle insurance coverage required in most states is only liability: bodily injury liability and property damage liability. Other forms of coverage, such as collision and comprehensive, are often optional. Comprehensive coverage for motorcycles, similar to how it operates under car insurance, can protect your motorcycle against threats other than collision, including fire damage, theft and vandalism. No matter where you live, motorcycle insurance is often mandatory for all who own a motorcycle.

Life Insurance

Life insurance provides a payout (known as the “death benefit”) to a chosen person (known as the “beneficiary”) at the time of your death. This coverage is purchased by a wide range of folks, including adults who want to protect the financial future of their spouse or dependents. However, even those without dependents may purchase life insurance to be able to donate to a charity or other organization after they pass. Life insurance is also commonly purchased to cover end-of-life expenses, such as funeral costs or remaining mortgage. This coverage is optional and not required by law.

Health Insurance

Health insurance provides reimbursement for medical expenses, including doctor visits, prescription medications and other covered expenses. A few select states currently require health insurance by law, including California, Massachusetts, New Jersey, Rhode Island, Vermont and Washington D.C. Folks in these areas may face state penalties if they don’t purchase health insurance (excluding Vermont). Still, coverage is no longer mandatory at a federal level. Many individuals purchase health insurance, including those who require frequent doctor or hospital visits, have ongoing medical expenses, and need expensive prescriptions or regular procedures.

Renters Insurance

Renters insurance provides similar protection to home insurance, but policies are designed for and purchased by folks who rent their homes. Renters insurance covers many of the same disasters home insurance does, including fire damage, vandalism, theft and lawsuits against you for bodily injury or personal property damage to others. In contrast to home insurance, renters insurance focuses on protecting your personal property since you don't own your home's dwelling. This coverage is often made mandatory by the company you rent the apartment or house from before your lease can be approved.

Pet Insurance

Pet insurance operates similarly to how health insurance works for humans and is often purchased by folks who have pets that may require frequent, expensive veterinary trips or medications. Coverage is available at three different levels, and basic coverage can protect against accidental injuries, poisonings and sickness. Comprehensive pet insurance provides more in-depth coverage for emergencies, vet office visits, tests, X-rays and prescription medications. Pet Well Care protection is also available and includes reimbursement for preventive care like flea and heartworm treatments and vaccinations. Pet insurance is optional and not a required type of coverage.

Insurance is a vital asset for many folks who want to adequately protect their property, health, vehicles, pets or other aspects of their lives. But insurance also comes with specific jargon and concepts that many individuals may find confusing at first. MoneyGeek answered some of the most common insurance questions below to help clarify this important topic.

There’s more to insurance than premiums and deductibles. Learn more about insurance policy types, coverage options and tips for managing your policies in the references below.

• Life Insurance Riders: Everything You Need to Know: Riders can be purchased separately to enhance your insurance policy. Learn more about how life insurance riders can help you get more out of your coverage.
• The Average Cost of Health Insurance in 2022: Health insurance can cost significantly more than your home or auto insurance, but its premiums depend on many factors. Learn more about factors that influence your life insurance costs and how to find affordable coverage.
• What Is the Average Cost of Auto Insurance?: Auto insurance costs depend on many factors, including your location, age and even your credit score. Find out more about what influences your premiums.
• The Cheapest Car Insurance Companies & Quotes: Finding affordable car insurance can be easy when you know where to look for coverage. Find out some of this year's top-recommended, cheapest car insurance companies.