Insurance: Types, Benefits, Coverage and Limitation



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Nothing is certain in life; we are all aware of this concrete fact. No matter how much we try, there is no predicting the uncertainties that might greet us. As we age and build our lives, a career, and families, all of these responsibilities that we have towards our personal and professional lives further add to the anxiety. So, is there a way to ensure that you and your family can be shielded against these 'unwanted' surprises and financially provided for? Meet- Insurance Policies!  

This chapter will deal with all things insurance, ranging from what it is and how it works to its features and the types of insurance available. 

What Is Insurance?

Insurance is a tool of risk transfer. An insurance policy is a contract between the insurance company and you, the policyholder. In this contract, the insurance company promises to compensate you for a financial loss while you undertake to pay a premium to the company. 

Insurance covers unpredictable financial risks. 

How Does an Insurance Policy Work?

Nobody knows how and when an emergency will strike, but we all know that we might suffer a financial loss should it occur.

To cover the financial risk, one may buy insurance. The insurance company collects the premium from the insurance buyers, pools it into a corpus and invests part of the money across various assets for capital growth. Out of the insured group, not everyone suffers the covered loss, and not everyone makes a claim. 

The insurance company uses the pooled corpus to pay the individuals who submit an insurance claim. Thus, in insurance, the losses of a few are shared amongst a group exposed to the risk of similar losses.

Let’s understand with an example. 

Say, in a village of 100 huts, 2 huts, on average, catch fire yearly. The cost of remaking a damaged hut comes to ₹20,000. Out of the 100 families living in the village, no family can predict which hut will catch fire. So, all 100 families are exposed to the same risk. This is the first basis of insurance.

To cover their collective risk, the families resort to insurance. Now, ₹40,000 will be needed to rebuild two huts damaged in a fire. Each family, thus, contributes ₹400 (₹40,000 / 100) to create a pool of ₹40,000. 

When the two huts get damaged, and the insurance company uses the pooled money to pay the two families that suffered the loss. Thus, insurance helps mitigate the financial risks of two families by spreading it across 100 families that are exposed to the same risk. This is how insurance works. 

Features of Insurance Coverage

Some of the salient features of an insurance policy are as follows -

  • There are different types of insurance plans. Each plan covers a specific type of financial risk.
  • The policyholder pays a premium to insure the risk. Among other factors, the premium depends on the quantum of coverage selected. The coverage is the maximum liability that the insurance company undertakes to compensate.
  • Every insurance policy runs for a specific period during which the risk is covered. This period is called a policy term or tenure. You can renew the coverage for uninterrupted protection once the term is over.
  • Some insurance plans also help you save and create a financial corpus, while most plans only cover the financial risk that you are exposed to.
  • Insurance covers only those risks that can be financially estimated.

Types of Insurance

As mentioned earlier, there are different types of insurance plans. Here’s how they are segregated -

Basically, insurance can be divided into two broad categories - 

  • Life insurance -  It covers the risk of premature demise.
  • General/non-life insurance - It covers different types of risks other than the risk of premature demise.

Life insurance has different types of plans, which are defined below -

Term insurance 

A protection-oriented plan that covers the risk of premature demise.

Endowment insurance 

Endowment insurance is a savings-cum-insurance plan that covers the risk of premature demise. The plan pays a death benefit on death and a maturity benefit if the insured survives the tenure. 

Unit Linked Insurance Plan (ULIP)

This plan invests the premium in market-linked securities and helps you grow your wealth with market-linked returns.

Pension Plan

Retirement-oriented insurance plans help you plan a retirement fund and assure lifelong pension income. 

Similarly, general insurance plans come in different variants. The popular ones are as follows -

Health insurance 

Health insurance plans cover the medical bills  incurred in the case of a health-related emergency

Motor insurance 

This plan ensures the vehicle is protected against damages and third-party liabilities.

Travel insurance 

Travel insurance insures a particular trip and covers financial losses suffered during the trip.

Home insurance 

This plan covers the home's structure and its contents against natural and man-made losses. 

Commercial insurance 

Businesses use this plan to cover the risks that they face. Common plans include fire insurance, marine insurance, commercial general liability, etc.

Understanding Insurance Benefits

Some of the benefits of insurance are as follows -


  • Risk Cover


Insurance is a tool of risk protection. You can transfer your financial risk to the insurance company, which, in turn, provides coverage for the loss that you might suffer. With insurance, you can handle and manage the risks that you are prone to at cost-effective rates.

  • Financial security 

By insuring your risks and giving financial coverage against them, insurance gives you a sense of financial security. You are assured in the knowledge that if the risk strikes, you will be compensated for the financial loss that you face. This also gives peace of mind.


  • Tax benefits


Insurance also comes with various tax benefits. Section 80D offers you tax deductions on health insurance premiums paid during a financial year, with a maximum limit of ₹25,000. For individuals aged 60 years and above, the tax deduction limit is enhanced to ₹50,000 per fiscal year. Under Section 80C, you may also be eligible for an annual tax deduction of up to ₹1.5 lakh, and under the same section, tax deductions may be possible in the case of term insurance as well. 

Limitations of the Coverage

On the other hand, given below are some limitations of the coverage too -


  • No returns


Insurance plans are meant to provide coverage against risk. The premium that you pay earns no returns under most plans. Thus, you cannot use insurance for generating investment returns (except for some life insurance plans that allow returns and corpus creation).


  • No maturity benefit


Under general insurance plans, no benefit is paid if the policy term comes to an end and you don’t suffer any financial loss. You can also not get anything back for the premium that you paid. 

  • Technical 

Insurance plans, their features, terms, and conditions are a little 

technical. You need to understand how the policy works and what it offers to buy the right coverage for your needs. Otherwise, the risk of misselling is high.

The Bottom Line

Insurance is an essential risk management tool that is a must in your financial portfolio. So, understand what it means, how it works, and the types of plans available in the market. Assess your needs and then choose relevant insurance plans to cover them. Get financial security so that emergencies don’t cause a financial crisis. Regarding the technicality, check out some common insurance terminologies in the next chapter for a better understanding of insurance.


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