Paul Sanchez
When it comes to insurance, not all risks are created equal. Insurable risks are those that insurance companies will cover, and they can vary depending on the insurer and the policy. Pure risks, which include natural events like fires or floods, accidents, and property damage, are typically insurable. On the other hand, speculative risks, such as gambling and investing, are generally not covered by insurance companies. However, it's important to note that insurance is not always black and white, and the line between insurable and uninsurable risks can sometimes be blurry. Ultimately, insurers will only cover risks that they deem profitable and non-catastrophic.
| Characteristics | Values |
|---|---|
| Type of Risk | Pure Risk, Speculative Risk |
| Insurable | Pure Risk |
| Not Insurable | Speculative Risk |
| Pure Risk Characteristics | Due to chance, definiteness and measurability, statistical predictability, lack of catastrophic exposure, random selection, and large loss exposure |
| Speculative Risk Characteristics | Chance of loss, profit, or a possibility that nothing happens |
| Speculative Risk Examples | Gambling, investments, business ventures |
| Pure Risk Examples | Natural events (fires, floods), accidents (automobile crash, sports injury), personal risks, property risks, liability risks |
| Uninsurable Risks | Reputational risk, errors and omissions, intentional damage, consequential losses, inevitable risks, gradual damage, criminal acts, intentional wrongdoing |
| Insurable Interest | Right of property to be insured, interest of a beneficiary of a life insurance policy to prove need for the proceeds |
| Insurable Risk Criteria | Costly enough that a business is willing to pay a premium, not catastrophic, well-defined and has a clear, measurable value, random, outside the control of the policyholder |
| Premium | The amount paid to the insurance company for protection against a covered loss |
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What You'll Learn
Pure risk vs speculative risk
Pure risk refers to situations where the only outcome is loss. It is beyond human control and can only result in a loss or no loss, with no possibility of financial gain. Pure risks are typically insurable through liability, commercial, or personal insurance policies, allowing individuals and businesses to transfer the financial burden to an insurer. Examples of pure risks include natural events, such as fires, floods, and other accidents, such as automobile crashes. Pure risks embody most or all of the main elements of insurable risk, including "due to chance," definiteness and measurability, statistical predictability, lack of catastrophic exposure, random selection, and large loss exposure.
Speculative risk, on the other hand, is a category of risk that, when undertaken, results in an uncertain degree of gain or loss. It is usually a choice and not the result of uncontrollable circumstances. Speculative risks are considered controllable risks and are often voluntarily taken on. Examples of speculative risks include gambling, investing in stocks, and sports betting. Insurance companies rarely cover speculative risks.
The main difference between pure and speculative risk is the potential outcome. Pure risk only has the potential for loss, while speculative risk has the potential for both gain and loss. Additionally, pure risks are typically beyond human control, while speculative risks are often voluntarily taken on and considered controllable.
In terms of insurability, pure risks are typically insurable, while speculative risks are rarely insured. Insurance companies require the risk to result in economic hardship and be commonly understood between each party for it to be insurable. Speculative risks lack the core elements of insurability due to their uncertain nature.
It is important to note that insurance is a complex industry, and not all risks are equal. Some vulnerabilities are easier to predict and recover from, while others are more challenging to insure. Pure risks, due to their predictable nature, align with the traditional purpose of insurance, which is to protect against losses.
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Accidental loss
Accidental damage insurance covers you for accidents that occur in the home. For example, spilling red wine on a new carpet, or a family member knocking over the TV. You can add accidental damage insurance as an extra when you get a home insurance quote. It can be added to both contents insurance and buildings insurance, or both. Contents insurance should cover most objects inside your home, including TVs, jewellery, carpets, and sofas. Buildings insurance usually covers damage by weather, fire, or crime, and adding accidental damage insurance will cover unintentional accidents like drilling through a pipe.
Accidental damage insurance does have some exclusions. For example, damage caused by pets, vermin, or insects may not be covered. Damage caused by infestations may also be excluded. Additionally, if you are doing DIY and are unqualified to do so, you may not be covered for any damage caused. Poor workmanship and defective building materials are also typically excluded.
It is important to note that insurance companies require policyholders to submit proof of loss before they agree to pay for damages. Losses that occur more frequently or have higher benefits normally have higher premiums.
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Calculable loss
A risk is insurable when it is considered calculable and can be measured and tracked by actuaries who study data and probabilities for insurance companies. In other words, it must be a pure risk, embodying most or all of the following elements: "due to chance", definiteness and measurability, statistical predictability, lack of catastrophic exposure, random selection, and large loss exposure.
Pure risks are uncertain situations where there is an opportunity for loss and no chance of financial gain. Pure risks can be divided into three categories: personal risks that affect the income-earning power of the insured person, property risks, and liability risks that cover losses resulting from social interactions. Examples of pure risks include natural events, such as fires or floods, or other accidents, such as automobile crashes or an athlete seriously injuring themselves.
Speculative risks, on the other hand, lack the core elements of insurability and are almost never insured. Speculative risks are situations that might produce a profit or loss, such as business ventures or gambling transactions.
Insurance companies limit their losses by not taking on certain risks that are very likely to result in a loss. These are known as uninsurable risks, which pose an unknowable or unacceptable risk of loss or a situation in which insuring would be against the law. For example, reputational risk is challenging, if not impossible, for insurers to place a value on, and so it is typically uninsurable. Similarly, an actuary could not reasonably calculate a definitive probability of success or failure for marriage, making it an uninsurable risk.
Insurers use loss ratios to assess their financial health and profitability. The loss ratio is calculated by dividing the losses incurred in claims by the premium earned. A high loss ratio may indicate that a business is in financial distress.
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Catastrophic loss
Insurers use tools like the Catastrophe Loss Index (CLI) to quantify the magnitude of expected insurance claims from major disasters. The CLI helps insurers estimate and prepare for potential claims, as well as determine when and where to deploy insurance adjusters. Securitization of catastrophic loss risks, along with reinsurance and retrocession, are also employed to manage catastrophe risk and protect both insurers and the insured.
It is important to note that not all catastrophic losses are insurable. Catastrophic events often result in a large number of claims being filed simultaneously, making it challenging for insurers to manage risk effectively. As a result, certain geographical areas prone to natural disasters may have limited coverage options or higher premiums.
Overall, catastrophic loss insurance provides crucial protection against financial losses resulting from severe natural or human-made disasters. While it cannot prevent the devastation caused by these events, it helps individuals, businesses, and communities recover and rebuild in the aftermath.
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Reputational risk
An example of reputational risk is the 2016 scandal involving Wells Fargo, where millions of unauthorized accounts were opened by bankers. This resulted in fines and penalties, as well as a loss of business, and the company's reputation was severely damaged.
Despite the challenges, some experts argue that reputational risk will be addressed more frequently in broad aggregated policies in the future. As it becomes an increasing concern for businesses, particularly with the rise of social media, it is likely that more underwriters will start to address this type of risk in their policies.
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Frequently asked questions
Insurable risks are risks that insurance companies will cover. These include a wide range of losses, such as property damage, fire, theft, or lawsuits. Pure risks are the most common type of insurable risk.
Pure risks are risks that have no possibility of a positive outcome, only a negative outcome or no outcome at all. Examples include natural events like floods, fires, and earthquakes, as well as accidents like car crashes. Pure risks can be insured because they can be predicted and quantified, allowing insurers to set appropriate premiums.
Speculative risks have a chance of loss, profit, or a possibility that nothing happens. Typical examples include gambling and investments. Speculative risks are generally not considered insurable because they are unpredictable and cannot be easily quantified.
Uninsurable risks are those that are too costly, too probable, too susceptible to manipulation, or too catastrophic for insurers to cover. Examples include reputational risks, intentional damage to property, and gradual damage due to maintenance or wear and tear.
Insurers consider the likelihood and potential impact of a risk when determining insurability. The risk must be potentially costly enough that a business is willing to pay a premium to protect against it. It should be outside the control of the policyholder and not too catastrophic for the insurer to handle financially.
