Life holds many uncertainties, some of which can result in significant financial loss. Although there is no way to prevent loss in all instances, instruments such as insurance and guarantee (also spelled “guaranty”) provide a cushion against the most significant effects of unexpected events. Although both insurance and guarantees are designed to provide a measure of peace of mind, the two concepts differ from one another.
When you purchase insurance, you pay premiums, often monthly, to keep the coverage in force. In turn, the insurance provider promises to provide financial compensation in the instance of an event that results in harm or loss. For example, health insurance provides compensation to cover the costs of hospital stays, surgery and physician care. Auto insurance provides compensation to cover the costs of repairing or replacing your car after an accident. The amount of compensation you receive depends on the nature of the covered event and the value of the policy you have purchased and is not limited to the amount you have paid in premiums.
Insurance providers determine whether to extend many types of policies by a process called underwriting. With insurance underwriting, the insurance provider uses facts and information about you along with its own algorithm or formula to determine the risk of having to pay out compensation. The results of this calculation determine whether you will be approved or declined for coverage, as well as the cost of coverage and any restrictions the insurance provider imposes on your policy. For instance, if your home is located in an area known for high crime rates, your home insurance premium may be higher than that of someone with a home of similar value located in an area with lower crime.
A guarantee is a promise of performance to a beneficiary in the event that the person who would normally provide a service or good fails to do so. A guarantee inserts a third party into a legal agreement to provide an extra layer of protection for the beneficiary. For instance, if you promise to repair a customer’s car, but you fail to do so in a satisfactory manner, a guarantee would provide the customer with a full refund of any money paid.
Insurance Versus Guarantee
There are two major differences between insurance and guarantees. One difference is that insurance is a direct agreement between the insurance provider and the policyholder, while a guarantee involves an indirect agreement between a beneficiary and a third party, along with the primary agreement between the principal and beneficiary. A second difference is that insurance policy calculations are based on underwriting and possible loss, while a guarantee is focused strictly on performance or nonperformance. In addition, insurance providers or policyholders can cancel policies with notice, while guarantees often cannot be canceled.