Jane Dotson
Insurance is a means of protection against financial loss, and insurable risks are those that insurance companies are willing to assume and provide coverage for. There are several characteristics that define an insurable risk, and it is important to understand which statements regarding these risks are correct and which are not.
| Characteristics | Values |
|---|---|
| Insurable risks need to be statistically predictable | True |
| Insurable risk must involve a loss that is definite as to cause, time, place, and amount | True |
| Insureds can be randomly selected | False |
| Insurance cannot be mandatory | False |
| Insurance can cover damage caused by acts of war | False |
| Smokers are approved on a preferred basis | False |
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What You'll Learn
Insurance can be mandatory in some cases
Insurance is not always a choice—in some cases, it is mandatory. This is particularly true of auto insurance, which is compulsory in many places. In the US, for example, state laws require drivers to purchase certain types of auto insurance, such as liability insurance, and may mandate additional coverage for accidents involving uninsured or underinsured motorists. Some states have also introduced no-fault car insurance, known as personal injury protection (PIP) insurance, which covers the medical bills of any victims, regardless of who was at fault. Collision coverage and comprehensive coverage are also sometimes mandated.
Auto insurance is not the only type of insurance that can be mandatory. In the US, health insurance was federally mandated until 2017, and some states continue to impose tax penalties for those without coverage. Similarly, workers' compensation insurance is compulsory in most states for employers with a certain number of employees, and some states make it obligatory for certain occupations to carry professional indemnity insurance.
Outside of the US, the picture is similar. For instance, in the UK, it is a legal requirement for all drivers to have at least third-party car insurance, and in India, businesses with more than 20 employees are required by law to have employee insurance.
In summary, while insurance is often a matter of personal choice, there are many situations in which it is legally required. This is particularly true of auto insurance, which is compulsory in many jurisdictions, but also applies to other types of insurance, such as health insurance and workers' compensation insurance.
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Insurable risks need to be statistically predictable
Actuaries are professionals who mathematically, statistically, and financially analyse financial risk by running a plethora of statistical models and analyses. Some calculations rely on the "law of large numbers", which uses an extensive database to forecast anticipated losses. Other models are far more complex. Insurers need to be able to estimate how often particular losses might occur and the expected severity of these losses. Losses that occur more frequently and are more severe will drive up premiums.
Insurable risks must be statistically predictable, and they must also involve a loss that is definite in cause, time, place, and amount. The event causing the loss must be clearly identifiable, and the loss must be measurable. For example, if a loss rate is not predictable, it is less likely to be in an insurer's "appetite", meaning they won't want to take on that type of risk. Insurers need to be able to assess the risk statistically to set premiums and predict claims accurately.
A catastrophic risk for an insurance company is any type of loss that is so pervasive, expensive, or unpredictable that it would not be reasonable to offer coverage for it. Catastrophe perils, or larger risks, can still be insurable, but only if insurers believe they can quantify their potential for loss and charge appropriate premiums.
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Insurable risks must involve a definite loss
For a risk to be insurable, it must involve a definite loss. This means that the loss must be the result of an unintended action and must be unexpected in its exact timing and impact. The loss must also be definite in terms of cause, time, place, and amount.
Insurable losses are typically "pure" losses, meaning they result from an event for which there is only the opportunity for cost. They are also typically accidental, as insurers only pay out claims for loss events that are brought about through accidental means. This definition may vary from state to state, but the key principle is that the loss must be outside the control of the insured person. For example, common insurable risks include auto insurance for car accidents, homeowners' insurance for fire damage, and health insurance for medical expenses. These risks are calculable and have associated financial costs that warrant insurance coverage.
The probability of a loss occurring must be able to be estimated by insurance companies, who rely on statistical data and historical events to calculate risks and set appropriate premium rates. If the likelihood of a loss cannot be quantified, insurance companies cannot create an insurance plan for it. The loss must also be significant enough to impact an individual's financial stability, but it does not need to be catastrophic. Catastrophic risks are typically excluded from standard insurance policies, as they are considered to be any severe loss deemed too expensive, pervasive, or unpredictable for the insurance company.
Insurable risks must also have the prospect of both loss and gain. While there is a chance of loss, there is no expectation that an insurable risk will result in a gain. Insurance serves to cover losses, not to make profits. This is an important distinction in understanding how insurance works.
In summary, insurable risks must involve a definite loss that is accidental, calculable, significant, and outside the control of the insured person. The probability and cost of the loss must be able to be estimated, and the loss must not be catastrophic to the insurer. Understanding these elements of insurable risks can help individuals determine the appropriate coverage for their needs and make informed decisions to protect themselves and their assets.
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Insureds cannot be randomly selected
The statement "insureds cannot be randomly selected" is correct in the context of insurable risks. Insurers employ a meticulous process of risk assessment and classification before underwriting policies, ensuring they are not insuring randomly selected individuals. This proactive approach helps prevent adverse selection, where only high-risk individuals seek insurance coverage.
In the insurance industry, adverse selection can pose significant challenges. If insurers were to randomly select insureds, they could end up with a disproportionate number of high-risk policyholders, leading to increased financial liabilities. To mitigate this risk, insurers use various tools and data to assess and classify risks before accepting a policyholder. This process allows them to accurately calculate premiums and maintain a balanced portfolio of policyholders with varying risk levels.
Insurers employ sophisticated methods to assess risk and select insureds. They utilise data analysis, actuarial science, and risk modelling to evaluate factors such as age, health, location, and previous claims history. By considering these factors, insurers can determine the likelihood of future claims and price their policies accordingly. This risk-based pricing ensures that premiums are commensurate with the level of risk presented by each insured.
Additionally, insurers often group individuals based on shared risk factors to facilitate more accurate premium calculations. For example, individuals in the same age group or geographical area may be considered collectively when determining premiums. This grouping approach allows insurers to spread their risk across a diverse range of policyholders, reducing their overall exposure to high-risk individuals or events.
In summary, the statement "insureds cannot be randomly selected" accurately reflects the careful risk assessment and selection process undertaken by insurers. By avoiding random selection, insurers can manage their exposure to adverse selection, maintain a balanced portfolio, and ultimately, ensure the sustainability and profitability of their business.
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Insurance cannot cover damage from acts of war
The war exclusion clause became widespread worldwide, and it is now established as a legal premise that insurance companies cannot be held liable for destruction caused by acts of war. The reason for this is that acts of war could result in thousands or millions of expensive claims, which could bankrupt insurance companies. Insurance companies also cannot accurately compute the premiums to charge for damages sustained by war.
The war exclusion clause became an important issue in the insurance industry following the terrorist attacks on New York City and Washington D.C. on September 11, 2001. Before the attacks, most war exclusion clauses applied only with respect to contractually assumed liability. After September 11, "war and terrorism" exclusions broadened the scope of the war exclusion clause.
It is worth noting that entities or individuals faced with a significant risk of war may be able to purchase a separate war risk insurance policy. For example, companies located in politically unstable countries may opt for this type of coverage.
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Frequently asked questions
Insurance cannot be mandatory. In some cases, insurance is required by law, such as auto insurance or health insurance in certain jurisdictions.
An insurable risk is a risk that an insurance company is willing to assume and provide coverage for. It needs to be statistically predictable and involve a loss that is definite in cause, time, place, and amount.
Adverse selection occurs when there are more high-risk individuals seeking insurance coverage, resulting in a higher probability of loss for the insurer. Underwriters must guard against this to manage the risk effectively.
No, insureds cannot be randomly selected. Insurers assess and classify risks before underwriting policies to ensure they are not insuring randomly selected individuals. This helps prevent adverse selection.
Automobile liability insurance is a type of mandatory insurance required by law in most jurisdictions. It ensures that drivers have a minimum level of financial protection in case of accidents or damage to their vehicles.
