Other Than Life (OTL) Practice Exam

What financial principle does insurance primarily operate on?

1. Surveillance

2. Indemnity

3. Speculation

4. Anticipation

The correct answer is: Indemnity

Insurance primarily operates on the principle of indemnity, which is designed to restore individuals or entities to their financial position prior to a loss. This principle ensures that when a policyholder experiences a loss covered by their insurance policy, they are compensated for that loss, but are not allowed to profit from the claim. Indemnity is crucial because it prevents policyholders from taking advantage of the insurance system by claiming more than their actual loss, which could lead to moral hazard—encouraging risky behavior if people know they will be compensated beyond their losses. The principle is enforced through various mechanisms, including deductibles and limits on coverage, which ensure that the insured only receives compensation equivalent to the actual financial damage suffered. In contrast, other choices relate to concepts that don't accurately depict how insurance operates. Surveillance involves monitoring activities and is not a financial principle. Speculation refers to investments made with the hope of achieving significant returns, which contrasts with the risk-pooling nature of insurance. Anticipation might involve predicting risks but does not encompass the foundational financial principle by which insurance compensates for realized losses.