What is the primary function of insurance in relation to risk?

The primary function of insurance in relation to risk is to transfer pure risk in consideration of the premium paid. Insurance is designed to provide a safety net by allowing individuals and businesses to share the financial consequences of certain risks. When a person purchases an insurance policy, they are effectively transferring the financial burden of specific risks, such as damage to property or liability, to the insurance company. In return for regular premium payments, the insurer agrees to cover certain losses outlined in the policy.

By accepting the risk from the insured party, insurance companies can pool these risks, spreading the potential losses across a large number of policyholders. This mechanism helps individuals and businesses manage unforeseen events without facing catastrophic financial hardships. Therefore, rather than eliminating risk entirely, insurance enables parties to maintain control over their exposure to financial losses, making it a critical tool in risk management.