Covariance is a measure of the volatility inherent in any venture or activity. Also indicates how two or more risk profiles, when combined, create more or less overall volatility. If several risk profiles are uncorrelated, the overall volatility may be lower compared to the individual risk profiles prior to aggregation. For example, a portfolio of high excess value property insurance transactions is not correlated with group directors and officers (D&O) liability policies and will therefore result in lower overall volatility if an insurer issues both types of coverage.
Insurance is a contractual relationship that arises when one party (the insurer), for a fee (premium), agrees to compensate the other party (the insured) for losses caused to a certain subject (risk) caused by certain unforeseen circumstances (hazards or dangers). The term ‘guarantee’, commonly used in England, is considered synonymous with ‘insurance’.