What is insurance?

What is Insurance?

Condominium Core Concepts Series - Module 1

As a foundation for understanding insurance policies, covered perils, and other concepts, we have to first understand what insurance is. Traditionally, insurance is a method of handling pure risk by spreading it out over a large number of people. This is seen today as a pool of policyholders that all buy insurance policies from the same insurance carrier through an insurance contract.

Let’s take a look at a Condominium Association, for example. They probably have physical property in the form of a building or buildings, landscaping, computers and furniture, appliances, etc. They may even have short-term rental units owned by the association. 

Now, what is the likelihood that an unforeseen storm or other event will damage their property? Or, in other words, what is the risk to the property? To help manage the risk of damage or financial loss, people can opt to transfer that risk to another party like an insurance company through an insurance contract. 

An insurance contract is where a person or group of people, the Insured(s), pay an insurance carrier, the Insurer, for an insurance policy so that when the Insured suffers a covered financial loss through property damage or some other covered loss like theft or fire, the Insurer will financially compensate them.

The Insured transfers the majority of their risk to the Insurer in exchange for paying premiums. We say they transfer the majority of the risk because the Insurer is going to ask the Insured to still pay a deductible in the event of a covered loss, meaning that they still share in some of the risk. 

As a final thought, we should state that the purpose of insurance is not to profit from a loss. The principle of indemnity is a critical component to every insurance contract and states that that an insurance policy shall not provide compensation to the policyholder that exceeds their actual loss under a replacement cost policy or contract. The benefits of a replacement cost insurance policy are typically limited to the extent needed to make the policy holder whole again or returned to the same or similar state they were in prior to the loss versus an actual cash value policy, where you are only reimbursed for the value of the loss but are free to use the funds as needed.