Fundamental principle of Insurance

The basic principle of insurance is that an individual or a business chooses to spend a definitely known sum (the premium) in place of a possibly huge, indefinite future loss. Thus insurance is the substitution of a small periodic payment for the risk of a large possible loss.

• The risk of loss still remains, but the loss is spread over a large number of policyholders exposed to the same risk.
• The premiums they pay are pooled, and the loss suffered by any one policyholder is compensated from this pool — so risks are shared with others.
• From the analysis of past events, the insurer (an insurance company or an underwriter) knows the probable losses caused by each type of risk covered.

Insurance as risk management

• Insurance is therefore a form of risk management used mainly to safeguard against the risk of potential financial loss.
• Ideally, it is the equitable transfer of the risk of a potential loss from one entity to another in exchange for a reasonable fee.
• An insurance company is an association, corporation or organisation engaged in the business of paying all legitimate claims that may arise, in exchange for a fee (the premium). …