Final answer:
Insurance is a financial protection system where insured parties pay premiums to cover potential losses from certain events, and receive compensation from the pooled funds if they incur a covered loss.
Step-by-step explanation:
Insurance is a method of protecting a person or entity from potential financial loss due to uncertain events. When individuals or businesses purchase insurance, they are required to make regular payments, known as premiums. The insurer calculates these premiums based on the likelihood of a claim being made by someone within the insured group. Then, if any members of the group suffer a loss that the insurance policy covers, they receive compensation from funds accumulated through these premiums. This system serves as a safeguard against the significant negative financial impact that certain events can have on a household or firm.
Moral hazard is a term associated with insurance, where insured individuals may be less vigilant in preventing the occurrence of an insured event, knowing that they have some protection against the financial consequences. Conversely, a money-back guarantee is a promise from a seller to refund a purchase under certain conditions, which is distinct from insurance but also related to financial protection.