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Fundamentals of Risk and Insurance, 11th Edition by Therese M. Vaughan, Emmett J. Vaughan

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CHAPTER OBJECTIVES

When you have finished this chapter, you should be able to

  • Define insurance from the viewpoint of the individual and of society
  • Identify and explain the two essential features in the operation of insurance
  • Explain how the law of large numbers supports the operation of the insurance mechanism
  • Identify and explain the desirable elements of an insurable risk
  • Explain what is meant by adverse selection and why it is a problem for insurers
  • Explain the economic contributions of insurance

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THE NATURE AND FUNCTIONS OF INSURANCE

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As we have seen, there are a number of ways of dealing with risk. In this book, we are concerned primarily with the most formal of these various approaches. We turn now to an examination of the insurance device, focusing on its nature and the manner in which it deals with risk.

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Risk Sharing and Risk Transfer

Insurance is a complicated and intricate mechanism, and it is consequently difficult to define. However, in its simplest aspect, it has two fundamental characteristics:

  1. Transferring or shifting risk from one individual to a group
  2. Sharing losses, ...

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