Insurance Principles and Concepts
Why insurance exists
Insurance transfers risk from one person to a pool of similar exposures. The law of large numbers lets an insurer predict aggregate losses, while adverse selection (only poor risks buying) and moral hazard (behavior changed by coverage) push against accurate pricing.
Contract characteristics
An insurance policy is a contract of adhesion (drafted by the insurer and construed against it when genuinely ambiguous), aleatory (unequal exchange contingent on an event), conditional (the insured must perform post-loss duties), and unilateral (only the insurer makes an enforceable promise once premium is paid). The doctrine of utmost good faith underlies the trio of representations, warranties, and concealment.
Indemnity and its limits
Indemnity caps recovery at the insured's actual financial loss. Actual cash value (replacement cost less depreciation) is the default measure; replacement cost is an optional upgrade. Insurable interest must exist at the time of loss for property insurance, but at inception for life. Subrogation lets an insurer pursue a negligent third party after paying, never for more than it paid. Contribution allocates a loss among concurrent insurers, and coinsurance shares a partial-insurance loss with the insured.
Traps
The exam loves to confuse when insurable interest must exist, to suggest subrogation allows double recovery, and to swap waiver (voluntary surrender of a known right) with estoppel (which requires detrimental reliance). Questions on causation test proximate cause - the dominant, efficient cause - not merely the last event in the chain.
Worked rule
A building valued at $1,000,000 carries an 80% coinsurance clause but only $600,000 of insurance; a $200,000 loss occurs; deductible is $5,000. Required limit = $800,000. Recovery = ($600,000 ÷ $800,000) × $200,000 = $150,000, less $5,000 = $145,000.