General Insurance Concepts: Risk, Insurability, and Contract Law
Risk, peril, and hazard
Risk is uncertainty concerning loss; peril is the cause of loss (fire, accident, illness); hazard is a condition that increases the chance or severity of loss. Physical hazards are tangible (icy steps). Moral hazards involve dishonesty (deliberate arson). Morale hazards involve indifference or carelessness (leaving keys in the car). Only pure risk - loss or no loss - is insurable. Speculative risk (loss or gain, as in gambling or stock investing) is not.
Insurable risk and the law of large numbers
An insurable risk is ideally accidental or fortuitous, definite as to time, place, cause and amount, calculable in advance, not catastrophic to the insurer, and shared across a large pool of homogeneous exposure units. The law of large numbers means actual experience approaches the predicted rate as the number of similar units grows. Adverse selection is the tendency of higher-risk people to seek coverage; underwriting counters it.
Contract characteristics
Insurance is a contract of adhesion (insurer drafts; ambiguity is construed against the drafter), aleatory (unequal exchange of value), unilateral (only the insurer makes an enforceable promise once the first premium is paid), and conditional (benefits depend on conditions), and it requires utmost good faith - accurate representations, no concealment, and compliance with warranties. Waiver is the voluntary surrender of a known right; estoppel prevents the insurer from denying that right if the insured relied on it. The parol evidence rule keeps prior oral statements from altering the written contract.
Trap: Insurable interest must exist at the time of loss for property-casualty insurance, but only at policy inception for life insurance. Also, moral hazard (dishonesty) is not morale hazard (carelessness).
Rule of thumb: The risk management techniques are STARR - Sharing, Transfer, Avoidance, Reduction, Retention. Insurance is a transfer.