General Insurance Concepts
Risk and how it is handled
Insurance deals with pure risk - the chance of loss only. Speculative risk (gain or loss, as in gambling or investing) is not insurable. Handling of risk follows the STARR list: Sharing, Transfer, Avoidance, Retention, Reduction. Insurance is transfer. Adverse selection - the tendency of poorer risks to seek coverage - is why underwriting and classification exist.
Core vocabulary
- Peril: the cause of loss (fire, accident, death). Hazard: a condition that increases the chance or severity of loss - physical (icy steps), moral (dishonesty, e.g., arson for profit), morale (carelessness because insured).
- Insurable interest: a financial stake such that loss causes a genuine economic loss.
- Indemnity: restore the insured to approximately the pre-loss financial position; no profit from loss.
- Utmost good faith: both parties disclose material facts; concealment or material misrepresentation can void coverage.
- Adhesion: the insurer writes the contract, so ambiguities are construed against the insurer.
- Aleatory: unequal exchange - one party may receive far more than it paid.
- Subrogation: after paying a claim, the insurer steps into the insured's shoes to recover from the at-fault party.
The law of large numbers
As the number of similar exposure units grows, actual loss experience converges on the predicted rate. This is why insurers need many similar risks to price accurately - and why a small, unusual group is hard to underwrite.
Reinsurance and self-insurance
Reinsurance is insurance for insurers; it spreads catastrophic exposure. Self-insurance is planned retention, not transfer.
Worked example: An insured intentionally burns his own warehouse. The loss is a pure risk event, but the moral hazard of intentional destruction defeats coverage under the concealment/fraud provisions - indemnity never rewards an intentional loss.