Insurance Basics
Insurance Basics & Risk
Core insurance concepts: risk, insurable interest, and key principles.
Risk & How Insurance Works
RISK is uncertainty of loss. Insurance transfers risk from the individual to the insurer, pooling premiums from many to pay the losses of a few.
• PURE RISK — only loss or no loss (insurable, e.g. a fire). • SPECULATIVE RISK — chance of loss OR gain (NOT insurable, e.g. gambling).
Only pure risk is insurable. The LAW OF LARGE NUMBERS lets insurers predict losses accurately across many policies.
Key Principles
• INSURABLE INTEREST — you must stand to suffer a financial loss; required (for property, at the time of loss). • INDEMNITY — restore the insured to their pre-loss financial condition (no profit from a loss). • UTMOST GOOD FAITH — both parties deal honestly. • SUBROGATION — the insurer can pursue the at-fault third party after paying a claim.
Indemnity prevents profiting from insurance.
Handling Risk & Hazards
Ways to handle risk (acronym STARR): Share, Transfer, Avoid, Reduce, Retain. Insurance is a form of risk TRANSFER.
• PERIL — the cause of loss (fire, theft, wind). • HAZARD — something that increases the chance/severity of loss. Physical (icy steps), moral (intent to cause loss for gain), and morale (carelessness) hazards.
📖 Key Terms
- Pure vs. speculative risk
- Pure = loss or no loss (insurable); speculative = loss or gain (not insurable).
- Insurable interest
- A financial stake such that you'd suffer a loss; required for coverage.
- Indemnity
- Restoring the insured to pre-loss condition without profit.
- Subrogation
- The insurer's right to recover from the at-fault party after paying a claim.
💡 Exam Tips
- ▸Only pure risk (loss or no loss) is insurable.
- ▸Indemnity means no profiting from a loss.
- ▸Peril is the cause of loss; hazard increases the chance/severity.
- ▸Subrogation lets the insurer pursue the at-fault third party.