Basic Characteristics of Insurance

Based on the preceding definition, an insurance plan or arrangement typically includes the following characteristics:

• Pooling of losses

• Payment of fortuitous losses

• Risk transfer

• Indemnification

Pooling of Losses

Pooling or the sharing of losses is the essence of insurance. Pooling is the spreading of losses incurred by the few over the entire group, so that in the process, average loss is substituted for actual loss. In addition, pooling involves the grouping of a large number of exposure units so that the law of large numbers can operate to provide a substantially accurate prediction of future losses. Ideally, there should be a large number of similar, but not necessarily identical, exposure units that are ..                                        

PAYMENT OF FORTUITOUS LOSSES

 A second characteristic of private insurance is the payment of fortuitous losses. A fortuitous loss is one that is unforeseen and unexpected and occurs as a result of chance. In other words, the loss must be accidental. The law of large numbers is based on the assumption that losses are accidental and occur randomly. 

 RISK TRANSFER 

Risk transfer is another essential element of insurance. With the exception of self- insurance, a true insurance plan always involves risk transfer. Risk transfer means that a pure risk is transferred from the insured to the insurer, who typically is in a stronger financial position to pay the loss than the insured. From the view point of the individual, pure risks that are typically transferred to insurers include the risk of premature death, poor health, disability, destruction and theft of property, and liability lawsuits. 

 INDEMNIFICATION 

A final characteristic of insurance is indemnification for losses. Indemnification means that the insured is resorted to his or her approximate financial position prior to the occurrence of the loss. Thus, if your house burns in a fire, the homeowner’s policy will indemnify you or restore you to your previous position. If you are sued because of the negligent operation of an automobile, your automobile liability insurance policy will pay those sums that you are legally obligated to pay.