Insurance Principles and Concepts
The building blocks
Insurance transfers a pure risk from an individual to a pool of similar exposure units. A risk is ideally insurable when losses are accidental, definite and measurable, large enough to matter, and spread across many similar units so that the law of large numbers makes aggregate losses predictable. That predictability is what underwriting, adverse selection control, and reinsurance protect.
Know the vocabulary cold:
- Peril - the cause of loss (fire, windstorm, theft).
- Hazard - a condition that raises the chance or severity of loss: physical (oily rags), moral (dishonest intent), morale (carelessness), legal (large jury verdicts).
- Indemnity - restoring the insured to roughly the pre-loss financial position, no better. ACV, deductibles, and subrogation all serve indemnity; subrogation never runs against the insurer's own insured.
- Insurable interest - property: must exist at the time of loss; life: at application.
- Utmost good faith - representations, concealment, warranties. The contract is one of adhesion (ambiguity favors the insured), aleatory, unilateral, and conditional.
Traps
Questions love swapping peril and hazard, mixing moral and morale hazard, and misstating when insurable interest must exist. Watch for "valued policy" (pays a stated amount) versus indemnity. Reinsurance is insurer-to-insurer and is never a consumer product.
Rule of thumb
Peril = what happens; hazard = what makes it worse or more likely. Lax housekeeping → morale hazard. Deliberate arson for money → moral hazard.
Worked example. A restaurant burns after grease builds up in a duct. Fire is the peril; the grease buildup is a physical hazard. Had the owner paid someone to start the fire, the loss becomes a moral hazard and the claim is denied.