General Insurance Concepts
Core vocabulary
Insurance transfers pure risk from an individual or business to an insurer in exchange for premium. A peril is the cause of loss, such as fire, illness, or an accident. A hazard increases the chance or severity of loss. Physical hazards are tangible conditions; moral hazards involve dishonesty; morale hazards involve carelessness or indifference. Speculative risk, which includes the chance of gain as well as loss, is generally uninsurable. Pure risk involves only loss or no loss and is the focus of insurance.
Other essential concepts include insurable interest, indemnity, adverse selection, the law of large numbers, retention, transfer, and reinsurance. Insurable interest is a financial or love-and-affection relationship that supports the contract; for life insurance it must exist at inception, not at death. Indemnity restores the insured to approximately the pre-loss financial position, but life insurance is not a strict indemnity contract because human life cannot be valued precisely. Adverse selection is the tendency of higher-risk people to seek coverage; underwriting, exclusions, and risk classification control it. Reinsurance is insurance for insurers.
Trap to avoid
Do not confuse peril with hazard. A slippery floor is a hazard; a fall is the peril; medical bills are the loss. Do not treat speculative risk as insurable.
Worked example
A homeowner leaves oily rags near a furnace. The rags are a physical hazard, spontaneous combustion is the peril, and fire damage is the loss. The insurer transfers the pure risk of fire damage in exchange for premium.