Most people will be familiar with insurance in some form or another. We all have taken out home insurance, car insurance or credit insurance among others. Insurance contracts are long and complex documents with a lot of small print. Sometimes even a lawyer would get lost in the complexities involved in them. However, there are a few features that all insurance contracts must have in common.

All insurance contracts will cover a chance event that may or may not occur. This is the risk you are insuring against. The event may be a fire in your home, a car accident, medical costs or virtually any other event. The sole exception to this is life insurance, which covers your death. This is an event that is bound to occur, however, it is the timing of death that is uncertain here.

There must be some quantifiable economic loss. Insurers will take on risks, but they must be able to quantify and predict the loss involved. The insurance company must be able to know roughly what kind of loss will be involved should the event occur. The loss must be quantifiable in monetary terms. For example, you may be able to insure yourself for medical expenses or a new car, but not for the sadness you experience as a result of an accident.

The loss must be definite. Again, insurers must know what kind of financial risks they are taking one; otherwise they will not be able to set the price of the premium.

The loss must be significant. The financial cost of the insured risk must justify the administrative costs of the insurance contract. Suppose you want to insure a racehorse. Someone will come from the insurance company, assess the value of the horse, write up a contract stating what’s covered and what conditions you must meet, calculate the premium and issue the contract. This will be worth all the effort for a valuable racehorse. However if you wanted to insure your goldfish, it would be difficult to justify the effort involved in setting up the contract.

The loss must not be catastrophic. What is catastrophic will depend on the size of the insurer and the assets they have available. But the insurance will not be worth anything if the loss is more than the insurer could afford. For example, insuring against an earthquake will often be impossible as the losses, should the event occur, would be impossible for the insurance company to ever pay out.