Insurance is a means of protection from financial loss in which, in exchange for a fee, a party agrees to guarantee another party compensation in the event of a certain loss, damage, or injury. It is a form of risk management, primarily used to hedge against the risk of a contingent or uncertain loss.

The insured receives a contract which details the conditions and circumstances under which the insurer will compensate the insured. The amount of money charged by the insurer to the contract holder for the coverage in the contract is called the premium. If the insured incurs a loss greater then the contract specifies the insurer will reimburse the insured for the loss. The insurer may hedge its own risk by taking out reinsurance, whereby the risk is sold to another party, especially if the primary insurer deems the risk too large for it to carry.

Insurability

Risk which can be insured typically share seven common characteristics

1. Large number of similar exposure units: Since insurance operates through pooling resources, the majority of insurance policies cover individual members of large classes, allowing insurers to benefit from the law of large numbers in which predicted losses are similar to the actual losses.

2. Definite loss: This type of loss takes place at a known time and place from a known cause.

3. Accidental loss: The event that constitutes the trigger of a claim should be fortuitous, or at least outside the control of the beneficiary of the insurance.

4. Large loss: The size of the loss must be meaningful from the perspective of the insured. Insurance premiums need to cover both the expected cost of losses, plus the cost of supplying the capital needed to reasonably assure that the insurer will be able to pay claims.

5. Affordable premium: If the likelihood of an insured event is so high, or the cost of the event so large, that the resulting premium is large relative to the amount of protection offered, then it is not likely that insurance will be purchased, even if on offer.

6. Calculable loss: There are two elements that must be at least estimable, if not formally calculable: the probability of loss and the attendant cost..

7. Limited risk of catastrophically large losses: Insurable losses are ideally independent and non-catastrophic, meaning that the losses do not happen all at once and that individual losses are not severe enough to bankrupt the insurer; insurers may prefer to limit their exposure to a loss from a single event to some small portion of their capital base.

Insurance contracts act as a way to transfer risk from the insured, the seller of risk, to the insurer, the buyer of risk.