According to risk management principles, what is the primary purpose of insurance?

The primary purpose of insurance is to cover large catastrophic losses. This principle is rooted in the concept of risk management, which aims to minimize financial uncertainty and protect individuals, businesses, and organizations from significant, unforeseen events. Insurance is designed to transfer the risk of large, potentially devastating financial losses from the insured party to the insurer.

By pooling the risks of many individuals or entities, insurance companies can provide coverage for substantial losses that would otherwise be difficult or impossible to bear financially. This includes events such as natural disasters, major liability claims, or severe accidents, which can lead to overwhelming costs that threaten the financial stability of individuals or organizations.

While insurance may also provide some level of cash flow or cover smaller losses, its primary function centers on mitigating the impact of significant threats. Consequently, options that suggest insurance primarily covers minor losses or ensures property appreciation do not align with fundamental risk management principles. Each policy is considered an investment in security against major risks rather than a means for guaranteeing consistent gains or managing minor financial bumps.