General Insurance Concepts: Risk, Insurable Interest, and Contract Principles
The vocabulary questions hinge on
Risk is uncertainty about loss. Peril is the cause of loss (fire, death, illness). Hazard increases the chance or severity of loss: physical (icy steps), moral (dishonesty, intent to cause loss), and morale (carelessness because insurance exists). Only pure risk (loss or no loss) is insurable; speculative risk (loss or gain, like investing) is not.
Insurable interest timing - a favorite trap
- Life insurance: interest must exist at policy application; it need not exist at death.
- Property insurance: interest must exist at the time of loss.
Contract characteristics
Insurance is a contract of adhesion (insurer writes it, so ambiguity is construed against the insurer), aleatory (unequal exchange - a small premium may buy a large benefit), and one of utmost good faith (both parties disclose material facts). A representation is a statement believed true; a warranty is a promise guaranteed true, and a material breach can void coverage. Subrogation lets an insurer pursue a third party after paying a claim, which supports the principle of indemnity - restoring the insured, not profiting them. Indemnity applies to property and liability, but life insurance is a valued contract paying the stated face amount.
Other concepts to know
Adverse selection, reinsurance (ceding risk and paying a retention), insurer types (stock, mutual, fraternal, reciprocal), distribution systems (career, independent, direct), and premium components (mortality, interest, expense).
Rule of thumb: hazard increases the chance of loss; peril is the cause of loss.