Q.Define insurance and explain how the principle of risk-sharing operates.

Insurance's defining mechanism is that many people share a small, certain cost so that a few, unlucky ones do not have to bear an entire loss alone.

Insurance is a contract (policy) under which the insurer, in exchange for a payment called the premium, promises to compensate the insured for a specified financial loss resulting from a defined uncertain event.

The risk-sharing (pooling) principle underlying insurance works as follows: a large number of people, each individually exposed to the same kind of risk, each pay a relatively small premium into a common fund managed by the insurer. In any given period, only a few of these policyholders will actually suffer the insured loss; the insurer pays their claims out of the fund built up from everyone's contributions. In this way, insurance does not prevent the loss from happening to any individual, but it spreads the financial burden of the loss across the whole group, so no single unlucky person bears the entire loss alone.

Describing insurance as though it prevents the loss itself — insurance only spreads and absorbs the FINANCIAL burden of a loss that has already occurred; it does not stop the fire, accident, or death from happening.