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CHAPTER 1: BASICS OF INSURANCE

CHAPTER 1: BASICS OF INSURANCE 




Let’s Begin…
Introduction



Insurance is an important part of our economy. Without the protection insurance affords us, we 
would have to spend more time and money protecting ourselves from the risks of loss and less 

time in enjoying life and pursuing goals.
Insurance is a very old concept. Basically, it means many people paying a little money to create 
a bigger pool of money so that anyone who is unfortunate enough to suffer a loss is reimbursed 
financially for that loss.


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First, insurance is designed to make a loss whole. In the simplest terms, a loss occurs when 
things you own are destroyed or reduced in value. If your house burns to the ground, 
insurance will provide the funds to rebuild it. The idea is to pay for your actual losses without 
allowing you to make money. This is what an insurer means by making the loss whole. 
In addition, it’s important to note that an insurance policy is a legally binding contract between 

One party is the insured person—you—and the other is the insurance company. 
As is true with all contracts, an insurance policy describes the rights and obligations of each 
party. In addition, the policy identifies how much you must pay to receive those rights. This 
amount is known as the premium. The policy identifies how much the insurance company is 
obligated to pay, if certain events should occur. The maximum amount an insurance company 
will have to pay is the limit of insurance.
The study of insurance is full of jargon that is unique to the industry. It is important to know 
these important basic concepts since you will encounter them throughout this course and in your 
practice of insurance.


Insurance Is a Business

It’s important to remember that insurance is a business. Some people may think of insurance 
as a service that helps people in times of need, insurance companies operate to produce a profit. 

Therefore, they want to collect more in premiums than they pay out in claims.
If all of an insurance company’s “insureds” filed claims at the same time, the company would go 
bankrupt. Fortunately, the odds of this happening are incredibly slim. To improve their odds, 

insurers will make some kinds of insurance (such as earthquake insurance in California and 
homeowners insurance in parts of Florida and other hurricane-prone areas) very hard to get—or 
very expensive.


If you file a lot of claims, your insurance company is going to raise your rates—not to punish you, 
but to make sure it can still earn a profit. Because claims often lead to higher rates, it is 
important to avoid filing small claims. 

Basic Concepts


The study of insurance is full of jargon that is unique to the industry. It is important to know 
these basic concepts since you will encounter them throughout your study of insurance. 
Who

Insured. Any person organization or company or a member of these specifically 
designated by name as the one(s) protected by the insurance policy. 

Insurer. The party to an insurance arrangement who undertakes to indemnify for 
losses, provide pecuniary benefits or render services. The word “insurer” is often used 
instead of “carrier” or “company” since it is applicable without ambiguity to all types of 
individuals or organizations performing the insurance function. The word insurer is 
generally used in statutory law.

Loss. Generally refers to (1) the amount of reduction in the value of an insured’s 
property caused by an insured peril, (2) the amount sought through an insured’s claim or 
(3) the amount paid on behalf of an insured under an insurance contract 

Exposure. The state of being subject to loss because of some hazard or contingency. 
Also used as a measure of the rating units or the premium base of a risk.

Proximate Cause. The effective cause of loss or damage. It is an unbroken chain of 
cause and effect between the occurrence of an insured peril or a negligent act and 
resulting injury or damage

Insuring Agreement (or Clause). That portion of an insurance contract which 
states the perils insured against, the persons and/or property covered, their locations 
and the period of the contract.

Claim. A demand made by the insured or the insured’s beneficiary, for payment of the 
benefits provided by the contract. 

Indemnify. To restore the victim of a loss to the same position as before the loss 
occurred. 

Insurance. A formal social device for reducing risk by transferring the risks of several 
individual entities to an insurer. The insurer agrees, for a consideration, to assume, to a 
specified extent, the losses suffered by the insured.

Insurable Events. Any contingent or unkown event, whether past or future, which 
may damnify a person having an insurable interest, or create a liability against him, may 
be insured against, suject to the provisions of the code.

Indemnity. To restore the victim of a loss to the same position as before the loss 
occurred.

Risk. Uncertainty as to the outcome of an event when two or more possibilities exist. 

2) A person or thing insured. There are two specific types of risk that are necessary to 
understand:

1. Pure Risk: No chance of gain or profit, and ONLY chance of loss.

Example: The risk of crashing a car and needing to replace it.

2. Speculative Risk: A chance of BOTH a gain or a loss

Example: The risk of gambling at a casino. Someone might win or lose.
NOTE: Speculative risks are NOT insurable.


RISK MANAGEMENT OF INSURANCE


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