Insurance and Risk Fundamentals
Core concepts
Insurance is a mechanism for transferring the financial consequences of specified risks from an individual to a pool of policyholders, in exchange for a premium. Candidates must be able to distinguish pure risk (only loss or no loss, e.g. fire) from speculative risk (gain or loss, e.g. share dealing), because only pure risks are insurable. Other insurability tests include: the loss must be fortuitous, definite and measurable, there must be a large number of similar exposure units to allow pooling, and the loss must not be catastrophic to the whole pool or against public policy.
Understand the difference between indemnity (restoring the insured to their pre-loss financial position) and new-for-old / agreed-value arrangements. Learn the principle of utmost good faith and the duty of fair presentation of risk at inception and renewal, plus insurable interest (you must benefit from the thing continuing to exist or suffer financially from its loss).
Traps
Questions often test moral hazard (behaviour changed by having cover) versus morale hazard (carelessness). Another trap is confusing avoidance, reduction, retention and transfer as risk-management responses - buying insurance is transfer, not avoidance. Watch for wording that asks which risk is uninsurable (speculative, or a certainty such as wear and tear).
Worked rule of thumb
For indemnity questions, ask: 'What is the financial loss at the time of loss?' A property worth £200,000 with a £50,000 rebuild cost that burns down is settled on rebuild cost (less any underinsurance), not market value. Use the average (underinsurance) condition: payout = loss × (sum insured ÷ required sum insured).