Principles of Insurance and Risk Management
This domain tests whether you can reason from first principles: why a policy responds at all, how much it should pay, and how the insured's own risk-management choices change the outcome. Expect short numerical items on indemnity, average and deductibles, plus conceptual items on insurable interest, good faith and proximate cause.
Core principles
- Insurable interest: the insured must benefit from the subject matter's safety or suffer loss from its damage; it is tested at inception for life business and at the time of loss for property.
- Indemnity: the insured is restored to the pre-loss financial position, no better and no worse - hence depreciation, salvage credits and average.
- Utmost good faith: the proposer must disclose every material fact a prudent underwriter would weigh.
- Proximate cause: the dominant, efficient cause - not the last event - decides whether a peril is covered.
- Subrogation and contribution: the insurer steps into the insured's recovery rights; where two policies cover the same loss, they share it rateably.
Where risk management fits
Identify, measure, control, then finance the residual risk. Retention appears as deductibles, co-insurance or self-insured layers; transfer is the policy itself. Distinguish hazard (a condition increasing severity, such as poor wiring) from peril (the cause of loss, such as fire) and be ready to name moral hazard and adverse selection.
Worked example
A warehouse is insured for 800,000,000 rials but its actual value is 1,000,000,000; a fire causes 200,000,000 of damage and the policy carries a 5,000,000 deductible. The policy is on a proportional basis, so average applies: 200,000,000 × (800/1,000) = 160,000,000, less the deductible = 155,000,000 payable.
Traps that cost marks
- Applying average to an agreed-value or reinstatement policy, where it is excluded.
- Treating the deductible as per item when the wording says per occurrence (or vice versa).
- Paying consequential loss (lost profit) as if it were direct damage.
- Confusing subrogation (recovery from the wrongdoer) with contribution (sharing between insurers).