What is the main purpose of insurance in managing financial risk?

The main purpose of insurance in managing financial risk is primarily about the transfer of risk. In the context of insurance, transferring risk means that individuals or businesses can shift the financial burden of potential losses to an insurance company in exchange for a premium. This allows policyholders to protect themselves against unpredictable and potentially devastating financial events.

The idea of spreading risk is closely related to the function of insurance. When many individuals purchase insurance, the insurer pools these risks together, enabling it to cover the losses of a few while those who do not suffer losses continue to pay their premiums. This broader base of insured individuals helps in managing overall risk exposure.

While maximizing profits and reducing liabilities are important considerations for insurance companies, these are more objectives of the insurers rather than the primary purpose of insurance for the insured. The central aim for individuals and businesses is to mitigate financial risk through the mechanism of risk transfer. Thus, understanding the core function of insurance helps clarify how it operates as a risk management tool in financial contexts.