Final answer:
Insurance is the transfer of the risk of a large loss to an insurer in exchange for regular premium payments. The premiums are priced based on the likelihood of events occurring among insured individuals or businesses, who are then compensated when covered events occur.
Step-by-step explanation:
The mechanism through which individuals or businesses exchange the possibility of a large loss for the certainty of a smaller periodic payment is known as insurance. Policy holders make regular payments, called premiums, to an insurance entity.
When an insured event occurs, the insurance company provides compensation to those who suffer significant financial damage from an event covered by the policy. This method helps in spreading the risk among a pool of policyholders.
However, it can lead to a scenario known as moral hazard, where individuals are less likely to take precautions against an event they are insured for, as the potential cost is borne by the insurer.