A Transfer System:
Insurance is a system that enables a person, a family or an organization (Insured) to transfer the cost of losses to an Insurer. By transferring the cost of losses to Insurers, Insured exchange the possibility of large loss for the certainty of a much smaller periodic payment called Premium.
Insurance Policy: A contract that states the rights and duties of both Insured and the Insurer regarding the transfer of costs of losses.
Covered Losses: The events for which Insurance pays.
Sharing the Cost of Losses:
Insurance also involves in Sharing the Cost of Losses. The Insurer pools (Combine into a common fund) premiums paid by insureds. When ever Insured incur covered loss then the claim is settled from these pooled funds, thereby spreading (sharing) the costs of losses among all the insureds. Insurer estimates future losses and expenses based on the past loss experience and determines the amount that should be collected from insureds as premiums.
Exposure unit: A measure of the loss exposure assumed by the insurer, used in pricing insurance.
Law of Large Numbers: A mathematical Principle stating that as the number of similar but independent exposure units increases, the relative accuracy of predictions about future outcomes (losses) based on these exposure units also increases.