What Is Insurance?

What's insurance and do I need it?

By Laura Rettie, Personal Finance Journalist. Last updated 1st May 2024.

Laura Rettie

Most of us have multiple insurance policies, but it can feel like a waste of money if we rarely make claims. So, do we really need all these policies?

What is insurance?

Insurance, in simple terms, is a contract between you and an insurer stating that they will provide you with compensation in the event of loss, damage or theft of the insured item or in the event of death or illness for life or health insurance policies.

All forms of insurance protect you from financial loss, whether it’s the cost of replacing a lost or damaged item or protecting you, your family or your business from unexpected expenses caused by a claim against you or that come as a result of illness or death.

How does insurance work?

When you take out an insurance policy, you pay a set amount, either annually or monthly; this is known as a premium.

Your premium is then pooled together with the premiums of everyone else who has insurance with that company. If you were to make a claim on your insurance policy, the insurer would use this pool of money to pay for your claim.

When you buy an insurance policy, the insurance company will set out certain terms, such as your premiums, the amount of excess you’ll need to pay, and what exactly the policy will cover.

These terms can change significantly between different insurers, so it’s important to compare insurance companies carefully before committing to anything.

What is excess?

When you take out insurance, you’ll agree to an excess amount with the insurance company. Excess is the amount you’ll need to pay every time you make a claim; opting for a higher excess can often reduce the cost of your insurance premium.

Before raising your excess amount, you’ll need to consider how much you can comfortably afford to pay if you need to make a claim.

There are two different types of excess; compulsory and voluntary. Compulsory excess is an amount set by your insurer, and it’s the lowest amount that they will accept. Voluntary excess is an additional amount you can choose to add to your compulsory excess to reduce the overall cost of your premium.

What are the different types of insurance?

Several different types of insurance are available; almost anything can be insured nowadays, so here’s a breakdown of some of the more common types of insurance.

Motor vehicle insurance

Motor vehicle insurance include cars, vans and motorbikes and is a legal requirement for anyone that owns a vehicle in the UK.

Car, van and motorbike insurance all have three levels of cover:

  • Third-party - third-party insurance is the most basic type of vehicle insurance and is a minimum legal requirement for anyone who owns a vehicle. Third-party insurance only covers damage or injury to third parties (other people, other vehicles or animals). This type of insurance will not cover any damage to or theft of your vehicle.
  • Third-party, fire and theft (TPFT) - this type of insurance is the next level of motor insurance; it’s similar to third-party insurance but will cover your vehicle against theft or damage from fire.
  • Comprehensive - Comprehensive insurance covers everything TPFT insurance covers and damage to your vehicle, even if an accident is your fault. Some comprehensive policies will also come with additional benefits, such as cover for driving your vehicle outside of the UK or insurance for the personal contents of your vehicle, such as a sat-nav.

Even without the legal requirement, insuring your vehicle is a must; our cars are often one of our most expensive possessions, and covering the damage to your own and someone else's car if you’re in an accident could cost thousands of pounds.

Home insurance

Home insurance, also known as house insurance, protects your home and your belongings. It’s split into two types of insurance, which you can choose to buy separately, or as a combined policy.

Buildings insurance

Buildings insurance covers the cost of repairing or rebuilding your home if it’s damaged by things like flooding, fire, subsidence, storms or vandalism.

Buildings insurance will often cover the roof, walls, floors and any permanent fixtures in your home, such as a kitchen or bathroom, plus any damage caused by leaking water pipes or accidental damage.

For most people, having buildings insurance is a must; if you own your home with a mortgage, your lender will often stipulate the property must be insured during the mortgage term.

Even if you own your home outright, it’s still a very good idea to take out buildings insurance, because the cost of repairing damage to your home can be extremely high, and isn’t something many people can afford in unexpected circumstances.

If you own a flat, it’s likely that you won’t need buildings insurance, because it’s often included in the cost of any maintenance fees or service charges for the building, but it’s always a good idea to double-check.

If you rent your home, you shouldn’t need buildings insurance, because it’s the responsibility of the landlord, though you may need renters insurance.

Contents insurance

Where buildings insurance covers damage to your home, contents insurance covers your possessions against loss, damage or theft.

Contents insurance covers a range of things, such as furniture, money, clothing, electrical appliances, bikes and gadgets.

There will often be a limit set out in your policy on how much you can claim per item, but you do have the option of separately listing some of the more expensive items in your home, such as computers, bicycles, art, jewellery or designer goods.

Bear in mind listing multiple high-value items could raise your premium, but it’s important to cover your most valuable possessions if you can’t afford to replace them if something goes wrong.

Mobile phone & gadget insurance

Some contents insurance policies will cover your mobile phone and other gadgets, even outside of your home, but not all. In this case, many people will take out separate gadget or mobile phone insurance policies to cover the loss, damage or theft of their phones, tablets, smartwatches or laptops.

Before taking out gadget insurance, it’s a good idea to check what’s covered in your contents insurance - mobile phone companies have a habit of upselling mobile phone insurance, which you don’t need if it’s included in your contents insurance.

Life insurance

Life insurance protects your family and loved ones financially in the event of your death. Whilst this can seem like a morbid subject, life insurance is extremely important if your family relies on your income or you have any debts, like a mortgage.

There are several types of life insurance, and the best one for you will depend on your financial and personal circumstances.

Term life insurance

There are three types of life insurance policies, although all only last for a certain period.

  • Level term - With level term life insurance policies, your lump sum will remain the same across the whole term.
  • Decreasing term - This type of term life insurance pays out less over time. It’s most commonly used to cover the remaining balance on your mortgage in the event of your death. As you repay your mortgage over time, the remaining balance gets lower every year, which is why decreasing term life insurance is most commonly used for this.
  • Increasing term - these types of policies are the opposite of decreasing term policies, and instead, the payout increases over time. These types of policies are commonly one of the most expensive life insurance policies.

Joint life insurance

This type of life insurance covers two people and is a popular option with parents and couples. However, there are a couple of different payout structures, and it’s important to understand them fully before taking out a joint life insurance policy.

The different payout structures are first-death and second-death. With first-death policies, the insurance ends, and the policy will payout in the event of the first person passing away. Second-death policies will only pay out when both policyholders pass away.

Whole of life insurance

Whole of life insurance lasts for your whole life. The policy doesn’t end until you pass away, and you’re guaranteed a certain payout just as long as you keep up with your premiums.

You can choose to keep your premiums the same for the rest of your life with balanced cover, or you can choose maximum cover, where your premiums will change over time.

Critical illness cover

Critical illness is often an add-on to a life insurance policy and can help you and your family cope with the financial impact if you become critically ill.

Critical illness cover pays out when you’re diagnosed with a critical illness and can provide peace of mind if your family relies on your income and can help cover the cost of any care or equipment you may need.

Health insurance

Health insurance can help cover the cost of private medical treatment for a pre-agreed list of medical conditions. This list can vary from policy to policy; some insurers will only cover a portion of the cost of private medical care.

In the UK, health insurance can often be considered an unnecessary expense due to the existence of NHS. Whether or not you need health insurance is a personal choice, and it’s important to remember that pre-existing medical conditions and chronic or incurable illnesses are rarely covered.

Pet insurance

Medical treatment for our beloved pets can be pricey, but pet insurance will cover your veterinary bills in the event of an emergency.

If your pet was involved in an accident the cost of appointments, treatments and medicines could quickly reach thousands of pounds, so if you’re a pet owner, pet insurance is a necessity for peace of mind.

If you have more than one pet, you’ll often be able to get them all covered under one policy, but you may need a specialist policy if your pet has any pre-existing medical conditions.

Travel insurance

If you’re going on holiday, or go abroad regularly, travel insurance is often considered a must.

Travel insurance covers emergency costs, such as medical costs if you were to become unwell or needed emergency assistance in the event of an accident, an unexpected need to extend your stay or the cost of flights home and legal assistance if you get into trouble or if you get stuck.

All of these situations can be extremely expensive, and travelling without insurance could end up costing you thousands of pounds.

There are a number of different types of travel insurance, such as:

  • Single trip insurance - If you’re only planning one trip in a year, single trip travel insurance is probably the best option for you, but be careful to check the policy covers everything you need it to.
  • Annual multi-trip insurance - If you’re lucky enough to take multiple trips abroad in a year, multi-trip insurance could be the most cost-effective option for you. It covers you for all your trips throughout the year, though different policies will have different terms, and there could be a maximum amount of time abroad covered, or it could exclude certain countries.
  • Cruise travel insurance - If you’re going on a cruise, you may need specialist insurance to cover you for any unexpected expenses that could arise, such as being ill at sea and having to leave the cruise early or missing your port stop because of bad weather.
  • Winter sports insurance - If you’re off on a skiing or snowboarding holiday, it's a good idea to take out winter sports insurance which will cover the cost of any equipment or costs incurred because of an accident.
  • Backpacker insurance - This type of insurance is designed for those travelling for an extended period of time or travelling to multiple countries.
  • Business travel insurance - If you take business trips abroad, business travel insurance will help protect any work equipment you end up having to carry around on your travels, such as a laptop and mobile phone.

Do I need insurance?

There are some insurance policies that you’re required by law to have, such as motor insurance if you own a vehicle.

If you’re applying for a mortgage, home insurance will often be a requirement set out by the mortgage lender before you’re approved.

Other types of insurance, whilst being a good idea and give you peace of mind, are entirely optional and you don’t have to have them.

When asking yourself if you need an insurance policy though, consider the repercussions of not having the policy.

For example, would you be able to comfortably replace the items in your home if you were burgled? Would your family be able to pay off your mortgage if you passed away? Could you afford the vets bills if your dog was run over? If you got sick when you were abroad, could you afford the hospital fees?

It’s common for people to think these things will never happen to them, so when money is tight, it’s tempting not to pay for contents, pet and travel insurance.

However, you have to ask yourself what would happen if any of the above events actually did occur. The likelihood of you being handed a bill for thousands of pounds if any of the above happened is almost certain.

For the sake of a small fee per month to cover yourself, you can leave your home, walk your dog and travel overseas confidently, knowing that if things go wrong you won’t be faced with huge fees that could leave you out of pocket.

It’s about managing risk and working out how likely you think these types of things could happen and what you can comfortably afford to pay for insurance vs what you could comfortably pay if things go wrong without insurance.

Ultimately insurance protects you and your family from financial difficulty in the event things don’t go to plan.

Having insurance reduces financial stress and in the event of an emergency, insurance allows you to focus on recovering from the event, instead of worrying about how you’re going to pay for it.

Yes you might go for years paying for insurance and never making a claim, which feels unfair, and a waste of money, but for the one time you do need it, you may feel incredibly thankful that you got yourself covered.

The information provided does not constitute financial advice, it’s always important to do your own research to ensure a financial product is right for your circumstances. If you’re unsure you should contact an independent financial advisor.