The transfer of risk to an entity that pools resources to compensate for losses associated with accidents, natural disasters, injuries, economic losses, and death. Individuals and businesses face uncertainty, which may result in the loss of value (risk). Risk may take various forms, including premature death, damage to property, and economic losses.
Besides risk transfer, some risks could be retained or controlled. Risk is retained when individuals and businesses assume responsibility for all or part of an unforeseen adverse occurrence. Drivers assume responsibility for part of the cost of an accident by their deductibles. Loss may be controlled by reducing the frequency of hazardous events or adopting safeguards to minimize the cost of eventual loss.
Insurance involves a contractual arrangement in which the insured promises to pay periodic premiums and the insurer takes an objective risk (the difference between actual losses and expected losses). Actuaries (skilled mathematicians and statisticians) determine the insurance premiums to cover compensation and profits.
Insurance companies take different organizational forms—stock companies (owned by shareholders), mutual companies (owned by policy owners), reciprocal exchange (self-owned unincorporated mutuals), and Lloyd's associations (associations that facilitate markets and services).
There are macroeconomic benefits from insurance. For example, the Federal Deposit Insurance Corporation (FDIC) insured deposits to develop confidence in the banking system and achieve financial stability in the aftermath of the Great Depression of the 1930s. It took on an even greater role of insuring deposits during the financial crisis of 2008. Insurance companies facilitate the transfer of articles of trade and promote capital formation by pooling resources and investing them in money and capital markets. For more information, see Kidwell, Blackwell, Whidbee, and Peterson (2008) in the bibliography.
Risk Management (economics)
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