General Insurance Concepts
Core vocabulary
Risk is uncertainty about loss. A peril is the cause of a loss, such as fire or death. A hazard is a condition that increases the chance or severity of loss. Physical hazards include icy steps; moral hazards involve dishonesty; morale hazards involve carelessness. Insurance handles pure risk, which involves only loss or no loss, not speculative risk, which can produce gain or loss.
How insurance works
Insurers pool many similar exposures, use the law of large numbers to predict losses, and avoid adverse selection through underwriting. Insurable interest must exist at policy inception for life insurance and at the time of loss for property insurance. Indemnity restores the insured to approximately the pre-loss financial position; life insurance is valued rather than strictly indemnity because a human life has no measurable cash value. Risk can be retained, transferred, avoided, or reduced through loss control. Reinsurance transfers risk from one insurer to another.
Traps
Students confuse peril with hazard, assume all risk is insurable, or apply property insurable-interest timing to life insurance. Stock insurers are owned by shareholders; mutual insurers are owned by policyholders.
Worked example
A wet floor is a hazard; a fall is the peril; medical bills are the loss. Rule of thumb: peril causes the loss; hazard makes the loss more likely or worse.