Insurance Principles and Concepts
Core principles
Insurance transfers the financial consequences of pure risk (loss or no loss), never speculative risk, which carries a chance of gain. Insurers pool many similar exposure units so actual losses approximate expected losses (law of large numbers). Adverse selection - buying coverage because you know you are a poor risk - is controlled through underwriting, exclusions, and waiting periods.
Insurable interest must exist at the time of loss for property and liability coverage; a mortgagee has one, a curious neighbor does not. Indemnity restores the insured to roughly pre-loss condition with no profit. Subrogation supports indemnity by letting the insurer pursue the negligent third party after paying, while the insured keeps any uncompensated remainder. Utmost good faith binds both sides through representations, concealment, and warranties.
Contract traits
Insurance contracts are contracts of adhesion (insurer drafts, ambiguity favors the insured), aleatory (unequal exchange), unilateral (only the insurer makes an enforceable promise), and conditional (benefits depend on the insured's compliance).
Risk management and hazards
Techniques: avoidance, loss reduction, retention, sharing, transfer. A peril is a cause of loss (fire, wind); a hazard increases the chance of loss - physical (icy steps), moral (dishonesty), or morale (indifference, such as leaving a door unlocked).
Trap watch
Questions swap peril and hazard, ask whether insurable interest must exist at application or at loss, and test apparent authority (authority a third party reasonably believes an agent has) against express and implied authority.
Worked example
A $100,000 building loss under an $80,000 limit with a $1,000 deductible pays $79,000. If a negligent contractor is legally liable for the full $100,000, the insurer subrogates for $79,000 and the insured may still pursue the remaining $21,000.