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What is insurance ?

In law and economics, insurance is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment.

An insurer is a company selling the insurance; an insured, or policyholder, is the person or entity buying the insurance policy.

The insurance rate is a factor used to determine the amount to be charged for a certain amount of insurance coverage, called the premium.

Risk management, the practice of appraising and controlling risk, has evolved as a discrete field of study and practice.

The transaction involves the insured assuming a guaranteed and known relatively small loss in the form of payment to the insurer in exchange for the insurer's promise to compensate (indemnify) the insured in the case of a financial (personal) loss.

The insured receives a contract, called the insurance policy, which details the conditions and circumstances under which the insured will be financially compensated.

What are the principles of insurance ?

Insurance involves pooling funds from many insured entities (known as exposures) to pay for the losses that some may incur.

The insured entities are therefore protected from risk for a fee, with the fee being dependent upon the frequency and severity of the event occurring.

In order to be insurable, the risk insured against must meet certain characteristics in order to be an insurable risk.

Insurance is a commercial enterprise and a major part of the financial services industry, but individual entities can also self-insure through saving money for possible future losses.

What are the effects of insurance ?

Insurance can have various effects on society through the way that it changes who bears the cost of losses and damage. On one hand it can increase fraud, on the other it can help societies and individuals prepare for catastrophes and mitigate the effects of catastrophes on both households and societies.

Insurance can influence the probability of losses through moral hazard, insurance fraud, and preventive steps by the insurance company.

Insurance scholars have typically used morale hazard to refer to the increased loss due to unintentional carelessness and moral hazard to refer to increased risk due to intentional carelessness or indifference.

Insurers attempt to address carelessness through inspections, policy provisions requiring certain types of maintenance, and possible discounts for loss mitigation efforts.

While in theory insurers could encourage investment in loss reduction, some commentators have argued that in practice insurers had historically not aggressively pursued loss control measures - particularly to prevent disaster losses such as hurricanes - because of concerns over rate reductions and legal battles.

However, since about 1996 insurers began to take a more active role in loss mitigation, such as through building codes.

Why are there different types of insurance ?

Any risk that can be quantified can potentially be insured. Specific kinds of risk that may give rise to claims are known as perils.

An insurance policy will set out in detail which perils are covered by the policy and which are not.

Below are non-exhaustive lists of the many different types of insurance that exist.

A single policy may cover risks in one or more of the categories set out below.

For example, vehicle insurance would typically cover both the property risk (theft or damage to the vehicle) and the liability risk (legal claims arising from an accident).

A home insurance policy in the U.S. typically includes coverage for damage to the home and the owner's belongings, certain legal claims against the owner, and even a small amount of coverage for medical expenses of guests who are injured on the owner's property.

Business insurance can take a number of different forms, such as the various kinds of professional liability insurance, also called professional indemnity (PI), which are discussed below under that name; and the business owner's policy (BOP), which packages into one policy many of the kinds of coverage that a business owner needs, in a way analogous to how homeowners' insurance packages the coverages that a homeowner needs.

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