Types of Insurance

The idea with insurance is that one party is exposed to some kind of risk (crashing a car, getting sick, dying, etc.), and they would like to transfer that risk away to someone else. Part of the transferring is converting the “risk” into “dollars,” which insurance companies do by assuming risk in exchange for payments. The insurance policyholder (“insured”) pays money (a “premium”) to the insurer. Then, if the insured-against-thing happens, the insurer pays out according to the policy terms.

This is an attractive proposition from the policyholder’s perspective because regularly paying a little bit each month or each year is frequently easier than coming up with a lot of money to cover an expensive, negative event. Thus, buying insurance through recurring premium payments is an attractive option compared to going uninsured and potentially facing a very large bill (and is in many cases legally or contractually required).

This is an attractive proposition from the insurance company’s perspective because they can pool the individual’s risks (and premium payments) with myriad other policyholders to create a fairly well defined “risk pool.” While the insurance company doesn’t know specifically which policyholders will have loss events, it does know roughly how many loss events in aggregate there will be and adjusts its prices accordingly. As long as it takes in more in premiums than it pays out for losses, the insurance company will make money. (Insurance companies make money in many other ways too, but this method is the original, basic idea underlying insurance.)

In the United States, insurance is spread across four categories: life, health, property, and casualty.

Life Insurance – an individual pays an insurance company premiums during their life; then, when they die, the insurance company pays a larger sum to the individual’s heirs or estate. (Life insurance comes in many different forms which we will discuss later.)

Health Insurance – an individual or their employer makes regular payments; then, if the individual falls ill, health insurance can pay for medical bills, prescriptions, dental, vision, and other health services. Health insurance will also typically include payments toward preventative health services.

Property Insurance – an individual pays periodic payments to protect their items--cars, homes, boats, buildings, personal goods, etc; then, if the insured property is damaged or destroyed, the insurance company pays to repair or replace the property.

Casualty Insurance – an insured entity pays to protect itself against potential future losses it would have a legal liability to pay. Both medical malpractice insurance and automobile insurance (protecting the insured party from paying in case of hitting another person’s vehicle) can fall into this category.

In practice, many insurance policies cover multiple categories, such as homeowners’ insurance and auto insurance, which combine property and casualty insurance.

What insurance do you need?

For most people who work in the technology industry, answers typically look like this:

• Life insurance – It depends on your family structure.
• Health Insurance – In the USA, yes.
• Property & Casualty Insurance – In some form, probably yes.

Do you need life insurance?

Life insurance helps your beneficiaries replace your income if you pass away. For example, the benefit payout money could help a spouse or children pay for a mortgage, education costs or everyday expenses. If you are a young, single person with no dependents, you probably do not need life insurance. You are the only one depending on your income, so if you die, there is no need to replace it. On the other hand, if you are a married parent with young children, you probably should buy life insurance to protect your partner and children from financial issues if you should die. If no one is currently relying on your earnings, you can probably hold off on buying life insurance until someone is.

Life insurance comes in two main types: “term life” and “permanent life” (also called “whole”). As suggested by the names, term life insurance is for a set period of time while permanent life insurance covers you until your death. Term life insurance is generally the lower-cost option and the most appropriate life insurance product for most people. Permanent life insurance can have some effective uses in advanced estate plans that use the nontaxable death benefit payout, but most purchasers of permanent life insurance products are probably overpaying for something they don’t need.

How much life insurance coverage do you need?

Most estimates for income-replacement life insurance recommend 10-15x your current income. For a worker earning $150,000, that equates to a policy with a death benefit between $1,500,000 and $2,250,000. This may cost you something like $50-100/month (depending on the provider you choose). Further, you should ensure your life insurance policy has enough coverage to pay off any outstanding debts you may have, including student loans, car loans, mortgages, credit cards, and personal loans.

Do you need health insurance?

The United States healthcare system operates on the assumption that its populace has health insurance. If you do not have health insurance, you are at a significant disadvantage in the system and are likely to face exorbitant costs.

Most health insurance in the US is provided through employers: either direct to the employee or to younger adults through their parents’ employment. Additionally, the Affordable Care Act created insurance exchanges that offer health insurance directly to individuals. While you may be able to skate by between policies without health insurance, its cost in the long term is likely to result in a very negative outcome, both medically and financially.

Do you need property & casualty insurance?

Property and casualty insurance is most applicable to high-cost items. If you own a car, for instance, you will need property and casualty insurance for it. Similarly, if you own a home, you will need homeowner’s insurance, a combination of property and casualty insurance. Even if you are only renting an apartment, most landlords will require renter’s insurance to protect their expensive asset. You will probably eventually encounter areas in which you will need a form of property or casualty insurance, but these specifics will vary based on an individual’s assets (vehicles, homes, expensive jewelry, etc.).