What is insurance & why do people need it?

What is insurance?

Insurance policies are designed to cover the cost of something going wrong. This might be the loss, damage or theft of material items, or it could be to cover the loss of income when someone dies or falls ill. When an individual is critically ill work or dies and is unable to work, an insurance policy would ensure that loved ones are financially cared for.

Medical insurance will cover private hospital treatment, while pet insurance covers vet bills for your cat or pet dog if they need treatment.

Insurance such as motor cover or household contents covers your possessions if you are involved in accident, you are robbed, or things are damaged from an incident like a fire or flood.

In return for paying money to an insurance company, known as a premium, policyholders receive an agreed level of protection. In the event something goes wrong, the insurer will pay compensation.

Typically, insurance is needed to cover the cost of items or instances that individuals cannot pay to replace when the worse happens. In some cases, insurance is compulsory – you must have car insurance to drive in the UK.

There is almost no end to the things you can insure; a chocolate taster at Cadbury has her taste buds insured for £1 million, for example. However, the most common types of insurance policy can cover;

• houses and property – to cover the cost of building repairs
• household contents and possessions – to pay for replacement possessions in the case of loss or theft.
• car insurance – in case of accident or theft.
• mortgages payments – if you lose your job
• health and private medical cover – if you prefer private medical care
• pets – for if your cat or dog or even more exotic pets need expensive treatment.
• critical illness – for if you are diagnosed with a serious or life limiting condition
• life cover – for death.
• travel insurance – to cover the additional costs and inconvenience if something goes wrong before or on your holiday.
• business – to ensure your business is protected in case of a liability claim.

There are many cost comparison websites that help you choose an insurance company. However, you can also use an insurance broker, call directly or visit an insurer’s website to get a quote

Insurance comparison site rewards

As you can see from our guides, comparison sites have made the cheapest insurance quotes very competiative. So in order to win business comparison sites offer rewards for customer to use their service. This is a comparison table of the rewards on offer from the major comparison sites as f June 2021.

How does insurance work?

When you take out insurance, you, the policyholder is passing the financial risk from something going wrong to an insurance company. If you do not need to make a claim, the insurer keeps the premium. If something does go wrong the insurer will pay for it to be solved.

The insurance company can do this by pooling individual premiums together to allow each policyholder to call on a large sum when things go wrong.

The customer will be asked a series of questions by the insurer who uses that information to set the policy and agree the terms of the insurance contract.

Once the individual has decided what they want to insure, they need to answer questions either online or over the phone. These are help the insurance company understand the level of risk involved in providing insurance, and will set the customer’s premium.

For example, when insuring your car, you will be asked whether you have been found guilty of a speeding offence. If you have, you will likely pay a higher premium than someone with no convictions because you are considered a higher risk. This risk is decided by the insurance company’s underwriter.

Failure to answer questions truthfully may be a criminal offence or result in the insurer refusing to pay out when you make a claim.

Once the questionnaire is complete, the insurer provides a quote. It is always wise to get several quotes since the amounts charged can vary significantly.

Should you need to make a claim, tell the insurance company as soon as possible. If you are insured against criminal activity, contact the police and get a crime reference number before contacting the insurer.

The insurer will provide you with a dedicated helpline to report the incident and your will need your policy number. Have as much detail as possible to help the company process your claim quickly.

Before the insurance company honours a claim, policyholders agree to pay an excess. The excess is set by the insurance company, but you can also agree a voluntary excess which will make the overall premium cheaper.

Depending on the policy detail and assuming the claim is accepted, the insurer will either provide financial recompense or arrange for items to be replaced or repaired.

Once you have made a claim, future premiums may increase.

The most popular types of insurance in the UK

The five most popular types of insurance in the UK, by number of households, are:

1. Motor
2. Contents
3. Buildings
4. Mortgage protection
5. Private medical

Only motor insurance is compulsory by law, but mortgage lenders often insist borrowers have buildings insurance.

Motor insurance

It is a criminal offence to drive on UK roads without car insurance.

There are three standard types of insurance:

• The most basic car insurance is third party and offers no other protection other than that required by law.
• Third party, fire and theft provides cover as above and against your car being stolen or catching fire.
• Fully comprehensive (fully comp) is the most popular type of car insurance and covers you and everyone in your car. It also pays out if the car is vandalised. Some comprehensive insurance covers you to drive other cars.

First time and young drivers who often face high premiums might consider black box insurance. Insurers fit cars with an electronic device that monitors how the vehicle is driven and encourages safe driving to keep premiums low.

Contents insurance

This covers the value of the items inside your home should they be stolen or damaged. Content usually refers to the things you would take if you move house such as furnishings, electricals and kitchenware, jewellery and antiques.

Policies vary hugely between insurers and will depend on what individuals deem valuable enough to cover. Contents cover may also incorporate legal expenses.

You can also choose to add on cover when you are away from the home.

Buildings insurance

This covers the structural integrity of a building and is based on the cost of rebuilding your house should it be destroyed.

Policies typically cover damage from natural disasters; vehicle collision; subsidence; fire; damage from falling objects. Individuals will usually need to pay for additional accidental cover.

Mortgage lenders will often demand that borrowers have buildings insurance, but it is worth all homeowners taking buildings insurance.

There are two standard types of building insurance:

1. Sum insured – calculated based on rebuilding the property, which is not the same as the market value.
2. Bedroom rated – based on the number of bedrooms. This can be expensive but prevents policyholders from being underinsured

Mortgage protection

Mortgage payment protection insurance (MPPI) covers your house repayments if you can no longer meet them.

There are three standard types of MPPI:

1. Unemployment only – covers you if you lose your job
2. Accident and sickness – covers only if you are ill or injured
3. Unemployment, accident and sickness – covers your mortgage repayments against all three

Private medical

Health insurance covers the cost of receiving private medical care. The benefits include jumping the queue for treatment and potentially better facilities and more comfort during treatment.

You can insure an individual, couple or family.

Employers sometimes offer health cover as part of a benefit package.

There are three standard types of health insurance

1. Basic – covers inpatient treatment
2. Medium – covers outpatient care as well as inpatient support
3. Comprehensive – usually includes after care, physiotherapy and mental health

Other common types of insurance

In addition to the main types of insurance, other common cover includes:

Travel Insurance

Travel insurance is an important cover for when you go on holiday. If you are abroad and fall ill or are injured outside the UK, you will pay for medical care which can run into thousands of pounds. Policies cover against this as well lost or stolen passport and travel money, and some cancellations. Insurers will also provide specialist cover for extreme sports.

Pet Insurance

Paying for medical treatment for pets can be extremely costly. Pet insurance can help cover the cost of unexpected illness or injury. However, pet insurance does not cover against any standard procedures such as microchipping or neutering, nor will it cover standard check-ups or pre-existing cover.

Life Insurance

this provides financial support for your loved ones on your death. The types of cover vary depending on your state of health, term of cover and the amount you want to receive.

There are three standard types of life insurance:

1. Level term:  pays out a set agreed lump sum if you die within the specified term.
2. Decreasing term: The lump sum decreases over the life of the policy to correspond with the amount you loved ones are likely to need on your death.
3. Increasing term: the amount you are covered for increases over the term of the policy to counter inflation.

Benefits of insurance

The main benefits from paying for insurance are:

1. Provides financial security when things go wrong. If you cannot afford to replace something if it breaks or is stolen, then it is worth insuring. If you are wholly reliant on one person’s income, that too is worth insuring.
2. Gives peace of mind to loved ones in the event of your illness or death.
3. Provides freedom to enjoy life which may be prohibitively expensive if things go wrong. For example, paying for hospital fees abroad or a pet’s operation which would be impossible without insurance.
4. Insurance can encourage positive behaviour. Insurers will only pay out if policyholders have adhered to certain expectations. For escape, locking the door when you go out, following rules and regulations when engaging in sport or travelling. Careful drivers also typically pay lower premiums on motor insurance.

Downsides of insurance

The major downsides from insurance are:

1. It can be expensive. Insurance premiums are on the rise and where no choice but insure, customers are at the insurers’ mercy.
2. It can be uncompetitive. When policies need to be renewed, insurers often quote an increase to the premium irrespective of whether a claim was made.
3. Policies can be confusing and complicated. Customers may think they are insured against an event, but the small print might exclude it.
4. Once you have paid the insurer you will not get your money back unless you make a claim. If you end the policy, the insurer will not return any payments made.

Major costs of insurance

Paying for insurance is all about understanding the risk/reward ratio. Ultimately if you can afford to replace an item or pay for the cost of an unexpected event, it may not be worth paying to insure it. But it can be a false economy not to have insurance if you rely on an item or income which you cannot replace when the worst happens.

Insurers will charge a premium which can be paid annually or monthly, but some insurers will charge more if the premium is not paid in one lump sum. If you pay your car insurance monthly, it can influence your credit score because you are entering a credit agreement which is effectively a loan.

Some employers offer insurance through their employee benefit package which can make insurance affordable and accessible.

If you choose to pay for insurance on a credit card, do not forget to factor in the potential additional APR.

Cathy Hudson

Cathy is a freelance journalist specialising in money, property and technology. She has been a journalist since 2001, starting her career writing about mortgages and property. Before becoming freelance in 2018 she worked at Which? for 12 years as a money writer and then an editor in the money, home, tech and cars teams on the magazines and website. As a freelancer she has written for Loveproperty.com, Lovemoney.com, Which?, Which? Computing, Which.co.uk, The i Paper, the London Evening Standard, Finder.com and Bankrate UK.