Insurance Risk Levels and Types

Risk, simply stated, is the probability that an event could occur that causes a loss. For an insurance company, risk will determine whether or not they may have to pay a claim. The amount of perceived risk being underwritten by an insurer will be used by you, the underwriter, to decide whether or not an insurance policy should be written for a particular individual. If the answer is yes, an accurate amount of premium to charge the insured to cover their particular insurance risk must be determined. For the insured, higher insurance risk means higher policy costs.

Issuance of Insurance Requires Measurable Insurance Risk

The entire insurance industry revolves around risk. Without risk, there would be no need for insurance companies and no need for your job as an insurance underwriter. As it is, your job in underwriting a policy is to determine if an insurance risk exists and, if it does, the level of that risk. The amount of perceived risk can significantly affect premium amounts.

An example of this is a young, healthy individual applying for a life insurance policy. Because he is young and healthy he is likely to receive lower premiums than an unhealthy, older individual because the younger man is less likely to die, thereby presenting a lower risk that the insurer will have to pay a death claim.

A driver with a history of accidents or speeding violations will undoubtedly be charged more for his automobile insurance coverage than someone with a clean driving record because he poses a higher risk to his insurer. An important factor in underwriting home insurance can be a thorough home insurance inspection, which is designed to uncover any risks found within a home that could lead to future claims against an issued policy. As the underwriter, you may want to insist that certain risks be mitigated by the homeowner before a policy can be finalized.

Insurance Risk Classifications

Risks can be considered in three classifications:

1. Financial and Non-Financial
2. Pure and Speculative
3. Fundamental and Particular

Some of these risks may be insurable while others may not. To qualify as insurable, a risk must contain seven specific elements.

Financial and Non-Financial Risks

Financial risks are those in which the outcome of a loss can be measured monetarily. These losses can be assessed and a financial value is given to them. Some examples include:

• Damage to property such as in a vehicle accident where a car is involved in a collision and must then be repaired or replaced
• Property theft
• Medical and/or court costs related to a personal injury
• Death of the breadwinner in a family

These are all losses that may be measured in financial terms and may be either repaired, replaced, or reinstated with an appropriate amount of funding. These represent insurable risks.

Non-financial risks are those whose losses cannot be measured in monetary terms, such as choosing the wrong car, the wrong spouse, the wrong menu item at a restaurant, or the wrong career. Even though the effects of these risks may cause discomfort, dislike, or embarrassment, they cannot be valued in monetary terms and are therefore uninsurable.

Pure and Speculative Risks

Pure risk, also referred to as absolute risk, is the potential for a loss to occur but without any corresponding potential for gain. Speculative risk, on the other hand, is the potential for either a gain or a loss to occur. An example is placing a bet on the roulette wheel in a casino. That bet, at the spin of the wheel, will either win or lose and, therefore, is not insurable. Pure risks, which are insurable, carry only the potential of loss or, at best, breaking even. Pure risk can have no potential for gain.

Fundamental and Particular risks may both be insurable but differ from each other in one specific way. Fundamental risk is related to events that usually arise from nature and cannot be controlled by any individual or group. Such risks include floods, earthquakes, tsunamis, hurricanes, tornadoes, cyclones, volcanic eruptions, drought, and other natural disasters.

Particular risk, on the other hand, relates to events that occur because of individual or group behavior. Particular risk may lead to a negative event resulting from someone not doing something that should have been done or doing something that should not have been done. Examples are fires started by carelessness or failure to conduct proper electrical system maintenance.

All Risks Cannot Be Avoided

While all risks cannot be avoided, steps can be taken to mitigate the cause of many risks and lessen the effects of events caused by them. Wearing seatbelts is a good example. Maintaining a tidy home with good security and regular maintenance is another. Requiring a home inspection of your home insurance applicants can help ensure lower risks.