18. Insurance

Insurance, in law and economics, is a form of risk management primarily used to hedge against the risk of a contingent loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for a premium, and can be thought of as a guaranteed small loss to prevent a large, possibly devastating loss. An insurer is a company selling the insurance; an insured is the person or entity buying the insurance. 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 Insurer (i.e. insurance company) and Insured (i.e. an individual) enter into a legal contract. The Insured pay a premium to the Insurer and in return the Insurer assures the Insured to compensate him against the losses or hazards mentioned in the contract. The Insured has an insurable interest in the subject matter (i.e. some property or life of certain individual). This means that the Insured stands to gain if the subject matter is protected against the hazards and will stand to lose if any damage is caused to the subject matter.

Insurance companies may be classified as Life insurance companies, which sell life insurance, annuities and pensions products. Non-life or general insurance companies, which sell other types of insurance. From the point of view of the insurance company there are four general criteria for deciding whether to insure events or not. There must be a larger number of similar objects so the financial outcome of insuring the pool of exposures is predictable. Therefore they can calculate a "fair" premium. The losses have to be accidental and unintentional (i.e., on the insured's part).

The losses must be measurable, identifiable in location and time, and definite. An insurer also requires that losses cause economic hardship. This so that the insured has an incentive to protect and preserve the property to minimize the probability that the losses occur. The loss potential to the insurer must be non-catastrophic, i.e., it cannot put the insurance company in financial jeopardy.