Sometimes I have seen legal contracts purporting to be insurance policies when, in reality, they did not function quite that way. So let us take a moment and talk a bit about what insurance is and how it works. Insurance policies are a risk management tool that work to transfer the risk of loss away from the policy-holder and onto the insurance company. The insurance company charges you a fee to assume your risk – these fees are called “premiumsâ€. An insurance policy is a legal contract that covers the financial loss associated with a peril. Of course that begs the question: what is a peril. A peril is an event that causes specific, measurable financial loss. In addition to perils, insurance folks like to talk about hazards. A hazard is an event or condition that makes the experience of a peril much more likely. Alright, this is best explained through the use of examples. Let’s say you apply for life insurance. Certain questions are asked about your health on the application. Your risk factors will be evaluated during the underwriting process as the company decides just what they’ll charge you for assuming the risk of your untimely demise. Certain risk factors can be considered hazards. Let’s say you are a smoker, have high blood pressure, or are overweight. All three of these conditions make it much more likely that you’ll develop further health complications resulting in death. Another question you may be asked on the application is whether you engage in dangerous hobbies such as rock climbing, skydiving, or Scuba diving. So in these instances, the hazards: smoking, having high blood pressure, obesity, SCUBA diving, skydiving, rock climbing; all increase the likelihood that you’ll suffer a loss due to peril. The potential perils: lung cancer, stroke, heart attack, drowning, or a fall from great heights all require the insurer to cover the resulting loss. I hope I have given you a taste of what an insurance policy is, as well as some understanding of hazards and perils. In my next post I plan to get a little more specific about some non-insurance insurance.