General Insurance Concepts
The vocabulary of risk
Risk is uncertainty about loss. Peril is the cause of a loss (fire, illness, accident). Hazard is a condition that increases the chance or severity of loss. Hazards come in three forms: physical (icy steps), moral (dishonesty, such as arson or faking a claim), and morale (carelessness, such as leaving keys in a car). Insurance handles pure risk, where the outcome is loss or no loss; speculative risk, which carries a chance of gain, is not insurable.
Characteristics of insurable risk
Many similar exposure units, accidental losses, losses that are measurable and determinable, losses not catastrophic to the insurer, and premiums that remain affordable. Adverse selection, the tendency of the worst risks to buy coverage, is controlled through underwriting.
Legal characteristics of the contract
- Offer and acceptance, consideration (premium plus application statements), legal purpose, competent parties.
- Adhesion: the insurer drafts the contract, so ambiguity is construed against it.
- Aleatory: values exchanged are unequal.
- Unilateral: only the insurer makes an enforceable promise.
- Conditional: benefits depend on the insured meeting conditions.
- Utmost good faith: enforced through representations (believed true) versus warranties (guaranteed), and through waiver and estoppel. An insurer that knowingly gives up a right cannot later reclaim it.
Traps
Do not confuse coinsurance with a copay, and remember subrogation is the insurer's right to recover from the at-fault party, not the insured's.
Rule of thumb
For any loss scenario, name the peril first, then the hazard, then whether the risk is pure or speculative. If the answer includes a chance of gain, it is not insurance.