General insurance principles and risk
Domain 1 tests how insurance transfers risk, how insurers pool and price it, and why underwriting and insurable interest exist. Expect questions that distinguish risk, peril, and hazard, and that apply insurable-risk criteria.
Core rules
- Risk is uncertainty about loss; peril is the cause of loss (fire, illness); hazard increases the chance or severity (icy steps, smoking).
- Only pure risk (loss or no loss) is normally insurable; speculative risk (gain or loss) is not.
- Insurable risks are accidental, measurable, definite, numerous and similar, and not so catastrophic that pooling fails.
- Pooling uses the law of large numbers: more independent exposure units make actual losses more predictable.
- Adverse selection is the tendency of higher-risk people to seek insurance; underwriting, exclusions, and rating classes control it. Moral hazard is careless behavior after coverage; morale hazard is indifference.
- Insurable interest is a financial loss from the event. For life insurance it must exist at application; for property it must exist at loss.
Worked example
An insurer expects 10 total losses among 1,000 homes insured for $200,000 each. Expected losses = 10 × $200,000 = $2,000,000. Pure premium per home = $2,000,000 ÷ 1,000 = $2,000. Add expenses, profit, and a risk margin to get the gross rate. If the insurer writes only 100 homes, one extra loss moves results far more, so it needs more margin or reinsurance.
Traps
Do not call speculative risk insurable. Do not say life insurable interest must continue after issue. Do not confuse hazard with peril.