Indiana State Life and Health Insurance Practice Exam

The primary purpose of an insurance policy is to?

1. Provide investment returns

2. Transfer risk

3. Maximize premium income

4. Eliminate financial loss

The correct answer is: Transfer risk

The primary purpose of an insurance policy is to transfer risk. Insurance is fundamentally about risk management; it enables individuals and businesses to shift the financial burden of potential losses to an insurance provider in exchange for paying a premium. This transfer of risk helps policyholders avoid the full financial impact of loss when unforeseen events occur, such as accidents, illnesses, or property damage. By pooling premiums from many policyholders, insurance companies can ensure that those who experience loss can receive compensation, thus safeguarding their financial stability. This entire mechanism is built on the concept of risk-sharing, where the insurance company assumes the risk associated with a policyholder’s potential loss, allowing them to recover and maintain their financial well-being. While some may think of other functions of insurance, such as providing investment returns or eliminating financial loss, the core purpose remains to manage and transfer risk. Other options may reflect aspects of insurance, but they do not capture the fundamental objective as precisely as the transfer of risk does.