Principles of Insurance

What are the basic principles of an insurance product (auto, homeowner, renters, etc).
Principles of Insurance - Articles
Principles of Insurance

Insurance is a product based on the fire insurance policy created by Benjamin Franklin in 1752 and was designed to cover pure risks--the uncertainty or chance of a loss from a situation or event that could occur. In a nutshell, Franklin created fire insurance by pooling together small monthly payments from residents who lived in an area. If you were an unlucky resident, had a house fire, and lost your dwelling and its contents, money from the fire fund would restore you to the position you were before the fire occurred. By a small amount of money in a common account (i.e., insurance company fund) regularly, if you had an unexpected event that was costly or financially devastating, money from the common account would restore you financially. Insurance is designed to help you maintain your financial status, not to increase your financial standing. This principal is called the principal of indemnity.

Principal of indemnity

States that a person is entitled to compensation only to the extent of the financial loss that occurred. In short, you cannot profit from a loss or be in a better financial position than you were before the loss occurred.

Law of Large Numbers

As the number of members in a group increases, predictions or guesses about the group's behavior become increasingly more accurate.

Under normal circumstances, given a large number of people who are insured, insurance companies can predict how many claims or incidents will occur in a given period and thereby predict the associated cost of the claims.

Principle of Insurable Interest

at the time a contract is signed, you must be subject to an emotional loss or financial hardship if a loss occurs.

Principle of Utmost Good Faith

requires that the insured (you) and the insurer (insurance company) be forthcoming with all relevant facts about the insured's risks and the coverage for risks. In short, both the insured and the insurer should tell the truth.

Authors

Personal Financial Education Consumer Education

More by Cathy F. Bowen, Ph.D.