What is the primary purpose of insurance?

The primary purpose of insurance is to transfer risk. Insurance operates on the principle that individuals or entities can share the risks they face with a larger group, allowing them to mitigate the financial impact of unforeseen events. When a person or company purchases insurance, they pay a premium in exchange for the insurer's commitment to cover certain financial losses that may arise from specified risks, such as accidents, illness, theft, or natural disasters.

This transfer of risk means that rather than one individual or organization bearing the entire financial burden of a loss, the risk is pooled among many policyholders. In essence, when a loss occurs, the insurance company uses the contributions from all its policyholders to provide financial support to the affected individual, thereby spreading the risk across a larger population. This mechanism is fundamental to how insurance functions and provides peace of mind to policyholders, knowing they have protection against certain adversities.

While identifying, reducing, and avoiding risks are important aspects of risk management in general, the defining characteristic and primary role of insurance is the mechanism it provides for transferring risk, thereby helping individuals and businesses manage their potential financial exposure.