When it comes to essential insurance terms, what you don’t understand can be costly. The insurance industry is one of the most jargon-laden. What you learn could help you save money when you shop for insurance quotes online.
See how you score on these 3 essential insurance terms
Indemnity is a fundamental insurance concept. In property and casualty insurance (think homeowners policies, auto insurance, and similar types), it means the insurer’s compensation for your loss will restore you to the same financial position you were in before a fire, car wreck or other covered peril occurred. The operative words here are same financial position. That’s why you can’t insure something for more than it’s worth and profit from its loss. It’s also why insurance takes into account depreciation when paying a claim. Maybe you paid $4,000 for your 1986 Yugo, but today it’s only worth $50. Sorry.
By contrast, life insurance is not an indemnity contract because your beneficiaries could end up in much better financial shape if you kick the bucket after paying just one premium.
Wouldn’t it be great if you could insure all those lottery tickets you blow a bundle on every year? You could take out a policy, pay a small premium and then, when you don’t win MEGA Millions, you could file a claim and get your “investment” back? No can do. No insurance company will write a policy on any kind of speculative risk. Remember, under the indemnity concept, you can’t profit from a loss. To be an insurable risk, it has to be a pure risk, meaning there’s a chance of loss or no loss (your house really could burn down or maybe it never will) but absolutely no chance of gain. But, hey, good luck with the lottery.
You’ve no doubt read about whacky insurance policies where celebrities insure their legs, voices and other assorted body parts from damage or loss. How come you can’t insure Kim Kardashian’s posterior, too? Or why can’t you take out a life insurance policy on the old geezer down the block? Because you don’t have an insurable interest, that’s why. In property and casualty lines of insurance, that means either you and/or your lien holder own the insured property when you take out the policy and when the loss happens.
In life insurance, the concept of insurable interest can include you, a relative by blood such as mother, father, brother, sister, child, parent or a spouse (no, you can’t insure your third-cousin or your ex-mother-in-law), certain business relationships (key employee, partner, etc.), or a creditor to whom you owe money. In the case of a creditor, the life insurance policy is used as collateral, and the face value of the creditor’s interest decreases relative to the outstanding balance of your debt.