Property and Casualty Insurance Practice Exam

What is the primary function of insurance?

1. To create income through investments

2. To transfer risk from individuals to the insurance company

3. To provide fixed compensation for all losses

4. To eliminate the possibility of financial loss

The correct answer is: To transfer risk from individuals to the insurance company

The primary function of insurance is to transfer risk from individuals to the insurance company. This concept revolves around the idea that individuals face various risks, such as property damage, liability, or health-related costs, which can lead to significant financial loss. By purchasing insurance, individuals pay premiums to the insurer, which in turn assumes the risk associated with potential losses. When a covered event occurs, the insurer compensates the policyholder, allowing them to recover financially without bearing the full brunt of the loss. This mechanism not only provides peace of mind to individuals but also promotes financial stability in society, as risks are pooled among many policyholders. Ultimately, the transfer of risk helps individuals manage uncertainties, contributing significantly to the overall economic wellbeing. The other options, while related to aspects of insurance, do not encapsulate its core function. For instance, while insurance companies may generate income through investments, this is a secondary activity rather than the primary purpose of insurance. Providing fixed compensation for all losses is not feasible, as insurance policies typically specify limits and coverage terms. Lastly, insurance does not eliminate the possibility of financial loss; instead, it mitigates the impact of such losses by providing financial protection.