There are several aspects of Insurable Risk. As a result, let’s start by grasping the most basic concepts and then build on the topic as we move forward. The article is supposed to be informational and strives to offer an insight to readers on insurable risk, its requirements, and the pros and cons encompassing the subject.
Defining Risk and Its Types
Risk involves the probability, whether high or low, of something terrible happening. The after-effects of an event taking place and the impact it’ll cause on a human’s valuables in unknown. A person may suffer substantial financial losses, loss of property, or even the loss of one’s life. There is a huge list of types of risks, and some major ones include:
- Business Risks- This majorly includes damage to machinery, logistics, sudden financial loss, and technical risks.
- Non-business Risks- Risks arising due to environmental changes or health issues come under this category.
- Financial Risks- Most of this involves investment risks and inflation risks.
All these types of risks can be categorized into two types:
Non-Insurable risks are the risks excluded by insurance companies because neither do they make money for shareholders nor come with accurate, reliable data of the mishappenings. Some examples are earthquakes, terrorist acts, wars, criminal activities. These risks are not something the insurer can decide a premium as nobody can calculate the loss precisely.
Insurable risks are the ones that first and most importantly meet the insurance company’s criteria for coverage. Pure risks, the ones that a human can’t control, come under this category. Losses due to fire, theft, accidents, and even health and life risks are included. Under an insurance policy, the person wanting insurance pays monthly or annual premiums to their insurance companies.
In return, the company agrees to cover and pay for you when you suffer a loss which the company’s policies cover. By collecting premium money from all the policyholders at regular intervals, the insurers can pay for the claims of those who suffer losses and promise everyone else that they would protected as and when needed.
Requirements of An Insurable Risk
There are specific requirements that need to be fulfilled to count a risk as insurable.
A large number of similar exposure units- Insurers use the law of large numbers to determine the risks. According to the law, the larger the number of similar but not identical units exposed to the same perils, the easier it is to predict loss based on the trial results. For example- automobile insurance covers millions of automobiles under it, but not everyone gets in an accident.
Accidental and unintentional loss- There must be some uncertainty surrounding the loss, and it should be completely unintended. An insurable risk should be outside the insured’s control. If the above conditions are fulfilled, then the insured gets paid for it. Losses such as vehicle accidents, health issues, fires, and loss of life fit this definition.
No catastrophic loss- Catastrophe insurance helps protect a business or residence against natural disasters such as floods and human-made disasters such as a riot. It also helps in case of unexpected and high medical emergencies.
Determinable and measurable loss- A loss that is both determinable and measurable and specific to cause, time, place, and amount. The most prominent example of this is life insurance policies. In most cases, the causes, time, and location of the casualty can be known easily. For business-related risks, the loss must be measurable and easily identified.
Calculable chances of loss- The insurer can calculate the average frequency and severity of these losses very conveniently using previous data with great accuracy. It helps in deciding the insurance premium one should be charged. For example, the data of road accidents in a particular country can be readily available, and with it, the future possibilities can be calculated. It should be noted that the more precise and comprehensive the data, the more accurately the premium can be calculated. When the data are very thin or murky, the insurance premium will be higher.
Economically feasible premium- The premium the insurance company asks for should be financially feasible for the insured to pay regularly without any fail, and it should be substantially less than the face value. A very high risk requires a very high premium. Sometimes, the premium is far more expensive than just being self-insured.
Every coin has two sides, and hence insurance has both its advantages and disadvantages-
- Insurance provides economic and financial protection to the insured against any sudden loss of property or death due to unintentional reasons in return for a very nominal premium.
- By sharing risks among the insureds, the company reduces the losses caused due to any uncertainty. Financial protection also helps in maintaining a standard of living in case of unexpected risks.
- It also encourages people to save and eliminate the dependency of a family or a few members in the loss of any life or property.
- An insurance policy can help in taking a loan by keeping the insured assets as collateral. It also helps in reducing inflation.
- It helps a business if it faces any massive loss due to unavoidable conditions and helps in proper and smooth running. Insurance for the employees provides them more encouragement to do their job.
- Insurance doesn’t and can’t cover any or every loss. It is a partial process.
- Even though it encourages savings, giving that money to a bank is still a more profitable option.
- It gives compensation by keeping in mind the goal of profit maximization and not the insured’s needs.
- It leads to crimes as the policy’s beneficiary may become greedy and commit atrocities to receive the insurance amount.
- Sometimes, the total amount to be received after the policy’s maturity may be lower than the premium paid.
You could look at insurance as a gamble, but it is really transferring risk to someone else. You could be self-insured, where you accept the risk – or you can be insured, where the insurance company takes the risk.
For example, some intellectual property risks can be transferred to an insurance company. Do you want to pay for an expensive lawsuit? If you do not have the resources for unexpected litigation, you can transfer that risk to an insurance company.