What is the primary function of insurance?

The primary function of insurance is to transfer risk from an individual to a larger group. This mechanism allows individuals or businesses to protect themselves against potential financial losses due to unforeseen events, such as accidents, natural disasters, or health issues. By pooling resources and sharing risks among many, insurers can provide security and stability for policyholders, ensuring that when a covered loss occurs, the financial impact is absorbed collectively rather than falling solely on the affected individual.

This concept of risk transfer is fundamental to how insurance operates. It allows individuals to pay a relatively small premium in exchange for the promise that, in the event of a claim, they will receive financial compensation from the insurer. The larger group mitigates the financial burden by spreading the risk across many policyholders, making it manageable for all involved.

The other options, while related to aspects of the insurance industry, do not capture the primary function as effectively. For example, while providing liquidity is important, it is more of a benefit that results from having insurance rather than its core purpose. Likewise, creating wealth for the insurer or establishing a contract of service are outcomes related to the business model of insurance rather than its fundamental role in risk management.