Insurance: is it risk transfer or risk financing, and who cares anyway?

It might seem a small detail, but insurance is not a transfer of risk. Transferring risk means that you found someone else to bear your exposure to loss.  Financing risk means you’ve made an arrangement for someone else to pay for your losses up to an agreed upon limit and under certain terms and conditions.

The reason it’s an important distinction is because when you are selecting your insurance, you’re choosing both an amount you want financed (your limits of coverage and the scope of coverage provided by the insurance policy), and an amount you will pay for yourself (deductibles plus excluded losses plus amounts in excess of the limits of coverage you choose).  Anything beyond the insurance you’ve bought is still your risk and you haven’t transferred it anywhere.

Thinking this way may help you conclude that it matters how good the policy is (insurance contracts DO differ among underwriters), and what your insurance priorities are when selecting limits of coverage.