In law and economics Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek οἰκονομία from οἶκος (oikos, "house") + νόμος (nomos, "custom" or "law"), hence "rules of the house(hold)". Current economic, insurance is a form of risk management Risk is defined in ISO 31000 as the effect of uncertainty on objectives . Risk management can therefore be considered the identification, assessment, and prioritization of risks followed by coordinated and economical application of resources to minimize, monitor, and control the probability and/or impact of unfortunate events or to maximize the primarily used to hedge In finance, a hedge is a position established in one market in an attempt to offset exposure to price fluctuations in some opposite position in another market with the goal of minimizing one's exposure to unwanted risk. There are many specific financial vehicles to accomplish this, including insurance policies, forward contracts, swaps, options, against the risk Risk concerns the deviation of one or more results of one or more future events from their expected value. Technically, the value of those results may be positive or negative. However, general usage tends to focus only on potential harm that may arise from a future event, which may accrue either from incurring a cost or by failing to attain some of a contingent, uncertain Uncertainty is a term used in subtly different ways in a number of fields, including philosophy, physics, statistics, economics, finance, insurance, psychology, sociology, engineering, and information science. It applies to predictions of future events, to physical measurements already made, or to the unknown loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment. An insurer is a company selling the insurance; an insured or policyholder is the person or entity buying the insurance policy. 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 Risk is defined in ISO 31000 as the effect of uncertainty on objectives . Risk management can therefore be considered the identification, assessment, and prioritization of risks followed by coordinated and economical application of resources to minimize, monitor, and control the probability and/or impact of unfortunate events or to maximize the, the practice of appraising A decision method is an axiomatic system that contains at least one action axiom and controlling risk, has evolved as a discrete field of study and practice.

The transaction involves the insured assuming a guaranteed and known relatively small loss in the form of payment to the insurer in exchange for the insurer's promise to compensate (indemnify An indemnity is a sum paid by A to B by way of compensation for a particular loss suffered by B. The indemnitor may or may not be responsible for the loss suffered by the indemnitee (B). Forms of indemnity include cash payments, repairs, replacement, and reinstatement) the insured in the case of a large, possibly devastating loss. The insured receives a contract In law, a contract is a legally binding agreement between two or more parties which, if it contains the elements of a valid legal agreement, is enforceable by law or by binding arbitration. A legally enforceable contract is an exchange of promises with specific legal remedies for breach. These can include compensatory remedy, whereby the called the insurance policy In insurance, the insurance policy is a contract between the insurer and the insured, known as the policyholder, which determines the claims which the insurer is legally required to pay. In exchange for payment, known as the premium, the insurer pays for damages to the insured which are caused by covered perils under the policy language. Insurance which details the conditions and circumstances under which the insured will be compensated.

Principles

Insurance involves pooling Pooling is a resource management term that refers to the grouping together of resources for the purposes of maximizing advantage and/or minimizing risk to the users. The term is used in many disciplines funds from many insured entities (known as exposures) in order to pay for relatively uncommon but severely devastating losses which can occur to these entities. The insured entities are therefore protected from risk for a fee, with the fee being dependent upon the frequency and severity of the event occurring. In order to be insurable, the risk insured against must meet certain characteristics in order to be an insurable risk. Insurance is a commercial enterprise and a major part of the financial services industry, but individual entities can also self-insure If self insurance is approached as a serious risk management technique, money is set aside using actuarial and insurance information and the law of large numbers so that the amount set aside is enough to cover the future uncertain loss through saving money for possible future losses.^[1]

Insurability

Risk which can be insured by private companies typically share seven common characteristics.^[2]

1. Large number of similar exposure units. Since insurance operates through pooling resources, the majority of insurance policies are provided for individual members of large classes, allowing insurers to benefit from the law of large numbers In probability theory, the law of large numbers is a theorem that describes the result of performing the same experiment a large number of times. According to the law, the average of the results obtained from a large number of trials should be close to the expected value, and will tend to become closer as more trials are performed in which predicted losses are similar to the actual losses. Exceptions include Lloyd's of London Lloyd's, also known as Lloyd's of London, is a British insurance and reinsurance market. It serves as a meeting place where multiple financial backers, underwriters, or members, whether individuals or corporations, come together to pool and spread risk. Unlike most of its competitors in the insurance and reinsurance industry, it is not a company, which is famous for insuring the life or health of actors, actresses and sports figures. However, all exposures will have particular differences, which may lead to different rates.
2. Definite Loss. The loss takes place at a known time, in a known place, and from a known cause. The classic example is death of an insured person on a life insurance policy. Fire, automobile accidents, and worker injuries may all easily meet this criterion. Other types of losses may only be definite in theory. Occupational disease, for instance, may involve prolonged exposure to injurious conditions where no specific time, place or cause is identifiable. Ideally, the time, place and cause of a loss should be clear enough that a reasonable person, with sufficient information, could objectively verify all three elements.
3. Accidental Loss. The event that constitutes the trigger of a claim should be fortuitous, or at least outside the control of the beneficiary of the insurance. The loss should be ‘pure,’ in the sense that it results from an event for which there is only the opportunity for cost. Events that contain speculative elements, such as ordinary business risks, are generally not considered insurable.
4. Large Loss. The size of the loss must be meaningful from the perspective of the insured. Insurance premiums need to cover both the expected cost of losses, plus the cost of issuing and administering the policy, adjusting losses, and supplying the capital needed to reasonably assure that the insurer will be able to pay claims. For small losses these latter costs may be several times the size of the expected cost of losses. There is little point in paying such costs unless the protection offered has real value to a buyer.
5. Affordable Premium. If the likelihood of an insured event is so high, or the cost of the event so large, that the resulting premium is large relative to the amount of protection offered, it is not likely that anyone will buy insurance, even if on offer. Further, as the accounting profession formally recognizes in financial accounting standards, the premium cannot be so large that there is not a reasonable chance of a significant loss to the insurer. If there is no such chance of loss, the transaction may have the form of insurance, but not the substance. (See the U.S. Financial Accounting Standards Board The Financial Accounting Standards Board is a private, not-for-profit organization whose primary purpose is to develop generally accepted accounting principles (GAAP) within the United States in the public's interest. The Securities and Exchange Commission (SEC) designated the FASB as the organization responsible for setting accounting standards standard number 113 This article is a list of Financial Accounting Standards Board pronouncements, which comprise Statements of Financial Accounting Standards ("SFAS" or simply "FAS"), Statements of Financial Accounting Concepts, Interpretations, Technical Bulletins, and Staff Positions, constitute rules and guidelines in preparing, presenting,)
6. Calculable Loss. There are two elements that must be at least estimable, if not formally calculable: the probability of loss, and the attendant cost. Probability of loss is generally an empirical exercise, while cost has more to do with the ability of a reasonable person in possession of a copy of the insurance policy and a proof of loss associated with a claim presented under that policy to make a reasonably definite and objective evaluation of the amount of the loss recoverable as a result of the claim.
7. Limited risk of catastrophically large losses. Insurable losses are ideally independent In probability theory, to say that two events are independent intuitively means that the occurrence of one event makes it neither more nor less probable that the other occurs. For example: and non-catastrophic The term is most commonly used for structural failures, but has often been extended to many other disciplines where total and irrecoverable loss occurs. Such failures are investigated using the methods of forensic engineering, which aims to isolate the cause or causes of failure, meaning that the one losses do not happen all at once and individual losses are not severe enough to bankrupt the insurer; insurers may prefer to limit their exposure to a loss from a single event to some small portion of their capital base, on the order of 5 percent In mathematics, a percentage is a way of expressing a number as a fraction of 100 . It is often denoted using the percent sign, "%", or the abbreviation "pct". For example, 45% (read as "forty-five percent") is equal to 45 / 100, or 0.45. Capital constrains insurers' ability to sell earthquake insurance as well as wind insurance in hurricane zones. In the U.S., flood risk Flood insurance denotes the specific insurance coverage against property loss from flooding. To determine risk factors for specific properties, insurers will often refer to topographical maps that denote lowlands and floodplains that are susceptible to flooding is insured by the federal government. In commercial fire insurance it is possible to find single properties whose total exposed value is well in excess of any individual insurer’s capital constraint. Such properties are generally shared among several insurers, or are insured by a single insurer who syndicates the risk into the reinsurance Reinsurance is insurance that is purchased by an insurance company from a reinsurer as a means of risk management, to transfer risk from the insurer to the reinsurer. The reinsurer and the insurer enter into a reinsurance agreement which details the conditions upon which the reinsurer would pay the insurer's losses (in terms of excess of loss or market.

Legal

When a company insures an individual entity, there are basic legal requirements. Several commonly cited legal principles of insurance include:^[3]

1. Indemnity An indemnity is a sum paid by A to B by way of compensation for a particular loss suffered by B. The indemnitor may or may not be responsible for the loss suffered by the indemnitee (B). Forms of indemnity include cash payments, repairs, replacement, and reinstatement – the insurance company indemnifies, or compensates the insured in the case of certain losses only up to the insured's interest
2. Insurable interest Insurable interest exists when an insured person derives a financial benefit from the continuous existence of the insured object or suffers a financial loss from the loss of the insured object. A person has an insurable interest in something when loss-of or damage-to that thing would cause the person to suffer a financial loss or other kind of – the insured typically must directly suffer from the loss. Insurable interest must exist whether property insurance or insurance on a person is involved. The concept requires that the insured have a "stake" in the loss or damage to the life or property insured. What that "stake" is will be determined by the kind of insurance involved and the nature of the property ownership or relationship between the persons.
3. Utmost good faith Insurance bad faith is a legal term of art that describes a tort claim that an insured person may have against an insurance company for its bad acts. Under the law of most jurisdictions in the United States, insurance companies owe a duty of good faith and fair dealing to the persons they insure. This duty is often referred to as the "implied – the insured and the insurer are bound by a good faith Good faith, or in Latin bona fides , is good, honest intention (even if producing unfortunate results) or belief. In law, it is the mental and moral state of honesty, conviction as to the truth or falsehood of a proposition or body of opinion, or as to the rectitude or depravity of a line of conduct. This concept is important in law, especially bond of honesty and fairness
4. Contribution – insurers which have similar obligations to the insured contribute in the indemnification, according to some method
5. Subrogation – the insurance company acquires legal rights to pursue recoveries on behalf of the insured; for example, the insurer may sue those liable for insured's loss
6. Causa Proxima or Proximate Cause – the cause of loss (the "peril") must be covered under the insuring agreement of the policy, and dominant cause must not be excluded An exclusion clause is a term in a contract that seeks to restrict the rights of the parties to the contract

Indemnification

To "indemnify" means to make whole again, or to be put in the position that one was in, to the extent possible, prior to the happening of a specified event or peril. Accordingly, life insurance is generally not considered to be indemnity insurance, but rather "contingent" insurance (i.e., a claim arises on the occurrence of a specified event). There are generally two types of insurance contracts that seek to indemnify an insured:

1. an "indemnity" policy and
2. a "pay on behalf" or "on behalf of"^[4] policy.

The difference is significant on paper, but rarely material in practice.

An "indemnity" policy will never pay claims until the insured has paid out of pocket to some third party; for example, a visitor to the home slips on a floor that you left wet and sues you for $10,000 and wins. Under an "indemnity" policy the homeowner would have to come up with the $10,000 to pay for the visitor's fall and then would be "indemnified" by the insurance carrier for the out of pocket costs (the $10,000).^[4][5]

Under the same situation, a "pay on behalf" policy, the insurance carrier would pay the claim and the insured (the homeowner) would not be out of pocket for anything. Most modern liability insurance is written on the basis of "pay on behalf" language.^[4]

An entity seeking to transfer risk (an individual, corporation, or association of any type, etc.) becomes the 'insured' party once risk is assumed by an 'insurer', the insuring party, by means of a contract In law, a contract is a legally binding agreement between two or more parties which, if it contains the elements of a valid legal agreement, is enforceable by law or by binding arbitration. A legally enforceable contract is an exchange of promises with specific legal remedies for breach. These can include compensatory remedy, whereby the, called an insurance 'policy'. Generally, an insurance contract includes, at a minimum, the following elements: the parties (the insurer, the insured, the beneficiaries), the premium, the period of coverage, the particular loss event covered, the amount of coverage (i.e., the amount to be paid to the insured or beneficiary in the event of a loss), and exclusions (events not covered). An insured is thus said to be "indemnified An indemnity is a sum paid by A to B by way of compensation for a particular loss suffered by B. The indemnitor may or may not be responsible for the loss suffered by the indemnitee (B). Forms of indemnity include cash payments, repairs, replacement, and reinstatement" against the loss covered in the policy.

When insured parties experience a loss for a specified peril, the coverage entitles the policyholder to make a 'claim' against the insurer for the covered amount of loss as specified by the policy. The fee paid by the insured to the insurer for assuming the risk is called the 'premium'. Insurance premiums from many insureds are used to fund accounts reserved for later payment of claims—in theory for a relatively few claimants—and for overhead In business, overhead, overhead cost or overhead expense refers to an ongoing expense of operating a business . The term overhead is usually used to group expenses that are necessary to the continued functioning of the business, but cannot be immediately associated with the products/services being offered (e.g. do not directly generate profits) costs. So long as an insurer maintains adequate funds set aside for anticipated losses (i.e., reserves), the remaining margin is an insurer's profit In accounting, profit is the difference between price and the costs of bringing to market whatever it is that is accounted as an enterprise in terms of the component costs of delivered goods and/or services and any operating or other expenses.

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