Exclusions are to partly designed to:
A provide protection against catastrophic losses.
B allow risk sharing.
C eliminate losses caused by uninsurable perils.
D provide indemnity.
The correct answer and explanation is:
The correct answer is C: eliminate losses caused by uninsurable perils.
Exclusions in insurance policies serve to clearly outline what is not covered under the policy. These exclusions are typically designed to remove certain risks from coverage that are deemed uninsurable, either due to their high potential for loss, their nature, or because they fall outside the scope of the insurer’s business model. Uninsurable perils can include things like war, nuclear disasters, and certain types of criminal activity.
Exclusions are necessary to prevent an insurance company from bearing the financial burden of risks that it cannot reasonably account for or predict. For instance, events like earthquakes, floods, or terrorism may be excluded because they are difficult to quantify in terms of risk, or because the potential for massive losses exceeds the insurer’s capacity. Without these exclusions, insurers would be exposed to uncontrollable financial risks, which could lead to unsustainable premium increases or insolvency.
Another reason for exclusions is that some risks can be covered by specialized policies. For example, flood insurance may be excluded from a standard homeowners’ policy but can be purchased separately through a specialized flood policy. This division helps to allocate risks more appropriately and keeps the primary policy affordable for the insured.
By clearly defining exclusions, insurance companies can better manage their risk exposure, while consumers can make informed decisions about the level and type of coverage they need. It also ensures that the intent of the insurance policy—providing financial protection against common risks—is maintained without overextending the insurer’s obligations.