General Insurance Concepts
Risk and the insurance mechanism
Insurance transfers pure risk (loss or no loss) from an individual to a pool. Insurable risks are measurable, accidental, definite as to time, cause and amount, spread across many similar exposure units, not catastrophic to the pool, and priced affordably. Speculative risk (chance of gain or loss) is not insurable.
Contract characteristics
Insurance is a contract of adhesion (the insurer drafts it), conditional, unilateral (only the insurer makes an enforceable promise), aleatory (unequal exchange of value), and one of utmost good faith. Property-casualty coverage requires insurable interest at the time of loss. A material warranty must be literally true; a representation need only be true to the best of the applicant's knowledge. Concealment of a material fact can void coverage. Waiver (voluntary surrender of a known right) and estoppel (barring an inconsistent position) can defeat a policy defense.
Measuring the loss
Actual cash value (ACV) = replacement cost minus depreciation; replacement cost pays new-for-old. Coinsurance shares the loss when the insured carries less than the required percentage. Occurrence policies respond to injury or damage during the policy period; claims-made policies respond to claims reported during the period, subject to retroactive dates and extended reporting options. Moral hazard is dishonesty; morale hazard is carelessness.
Worked example
Building replacement cost $1,000,000, 80% coinsurance required ($800,000), carried at $600,000. A $100,000 loss pays (600,000 ÷ 800,000) × 100,000 = $75,000, less the deductible. The insured is a coinsurer for the shortfall.
Rule of thumb: ACV = replacement cost − depreciation; coinsurance penalizes underinsurance.