What does 'risk transfer' in insurance entail?

Risk transfer in insurance refers to the process by which an individual or entity, known as the insured, shifts the financial burden of loss to an insurance company. By purchasing an insurance policy, the insured effectively transfers the responsibility of potential financial losses from specific risks covered by the policy to the insurer. This means that in the event of a loss—such as damage to property, medical expenses, or liability claims—the insurer will cover the costs according to the terms of the policy, thus providing financial protection for the insured.

This concept is foundational to the function of insurance, as it allows individuals and businesses to manage uncertainty by providing a safety net against significant financial setbacks. The payment made for this risk transfer is the insurance premium, which is a cost that provides peace of mind and financial security.

The other options do not accurately reflect the concept of risk transfer. For instance, assuming all risk contradicts the very nature of insurance, which is designed to alleviate risk, while increasing the chance of loss runs counter to the aim of risk management. Eliminating risk through premiums is misleading, as premiums are a cost associated with transferring risk rather than a method of removing it altogether.