What is insurance and how does it work?
Short answer
Insurance is a way to protect what you have if something goes wrong1. Policyholders pay premiums, which are pooled into a fund that pays the claims of those who suffer a loss. In return, the insurer agrees to compensate the policyholder for damage or loss covered by the policy2.
Why people insure
Moneysmart describes insurance as a safety net for when things go wrong, helping to cover costs such as repairs, medical treatment, travel changes or theft3. Its guidance on phone and laptop insurance notes that insurance may not be good value when you have enough savings to replace an item yourself4.
Some types of insurance protect your income, health or loved ones. Other types protect your home, car or belongings1.
Some insurance is required. Every registered car must have compulsory third party (CTP) insurance5. Employers must have workers compensation insurance6. Home insurance may be a condition of a home loan7.
How insurance works
The policy. An insurance policy is an agreement, usually for a year, to compensate the policyholder for damage or loss according to the policy’s terms2. The excess is the part of a claim that the policyholder pays, as set out in the policy8.
Pricing by risk. Insurers assess how likely a loss is and how much it could cost, and set premiums accordingly. This process is called underwriting2. Home and car insurance are risk rated, so premiums differ between policyholders. Private health insurance is different. It is community rated, so everyone pays the same price for a particular policy9.
Pooling. Premiums from policyholders are pooled into a fund that is used to pay claims. Premiums also cover reinsurance and running costs, and insurers earn income from low-risk investments2.
Insurance for insurers. Insurers buy reinsurance on a global market. It helps them pay claims when losses are higher than expected, such as after a major storm or flood2.
Keeping the promise. APRA supervises insurers so that they have enough financial means to meet their obligations to policyholders10. ASIC, Australia’s financial markets conduct regulator, requires insurers to hold a licence to handle and settle claims11; 12. If a dispute cannot be resolved with the insurer, the Australian Financial Complaints Authority (AFCA) offers free, independent complaint resolution13. If a general insurer fails, the Australian Government can activate the Financial Claims Scheme to pay valid claims14.
What insurance does not cover
Exclusions. Every policy lists events it does not cover. The standard cover set by regulation for home building, home contents and motor vehicle insurance excludes depreciation, and wear and tear, rust or corrosion15. Travel insurance often excludes acts of war, some natural disasters and pandemics, and travel and pet insurance often exclude pre-existing conditions16; 17.
High-risk properties. If a home is at high risk of flooding, insurance costs will be higher, or flood cover might be excluded18. APRA estimates that around one in seven households in freestanding houses are likely to be uninsured because their premiums are unaffordable19. Why are some households underinsured or uninsured? explains more.
Risks too large for private insurers alone. A 2018 Treasury review found that, without the government’s terrorism reinsurance pool, there would likely be a market failure in terrorism insurance20, p. 538. The government has also set up a cyclone reinsurance pool, backed by a $10 billion government guarantee21.
Learn more
- What types of insurance do households buy?
- Why are insurance premiums increasing in Australia?
- Who regulates home and car insurance in Australia?
- Why are some households underinsured or uninsured?
Last reviewed 7 November 2026.