Insurable Risks

Risks are generally divided into two classes: Pure risks and Speculative risks.

Pure Risks- these risks involve only the chance of loss, there is never an opportunity for gain or profit.
Examples: injury from an accident, loss of home from an earthquake.

Only Pure Risks are Insurable

Speculative Risks- These risks involve both the chance of gain or loss.
Examples: Gambling at the race track, or investing in the real estate market.

Speculative Risk is not Insurable

Elements of an Insurable Risk

  • Loss must not be Catastrophic
  • Loss must be Unexpected or Accidental
  • Loss produced by the risk must be Definite and Measurable
  • Must be a significantly large number of homogeneous exposure units to make the losses reasonable predictable

Risks can also be evaluated on an economic scale comparing static and dynamic risks:

Static Risks are the losses that are caused by factors other than a change in the economy (for example- hurricanes, earthquakes, other natural disasters)

Dynamic Risks are the result of the economy changing (examples- inflation, recession, and other business cycle changes). Dynamic risks are not insurable.

Practice Question:
Which of the following risks are considered insurable risks?
I. Static Risks
II. Dynamic Risks
III. Speculative Risks
IV. Pure Risks
V. Inflation Risk

A. I and IV only
B. II and IV only
C. I, IV, and V
D. I, II, III, IV, and V

Answer: A
Only pure risks are insurable. Static risks are a type of pure risk that tends to occur with regularity- they can be insured against. Dynamic, Inflation, and Speculative risks are all uninsurable.

Practice Question:
Which of the following is an element of insurable risk?
A. The loss must be unexpected or accidental
B. The loss must be catastrophic
C. The loss produced by the risk cannot be measurable
D. The loss must be damage related

Answer: A
The loss must be unexpected or accidental to be an insurable risk. It cannot be catastrophic and it must be measurable and definitive.

Self-Insurance
Self-insurance is the process of an individual or company acting like an insurance company to cover its own risks. This involves evaluating a large number of similar potential losses, the ability to predict the overall losses with some degree of accuracy, and the establishment of a formal fund for future losses and their possible fluctuations.

Self-Insurance for both companies and individuals has its pros and cons:
Advantages:
  • Avoid the cost of premiums for commercial or personal insurance
  • Reserves can be invested in short-term money market instruments and later used by the company or individual when the insurance is no longer needed

Disadvantages:
  • Company/individual is exposed to a catastrophic loss
  • Services provided by the insurance company are assumed
  • Income taxes may be due on the interest/profit from the reserve cash
The Risk Management Process

Related Articles
  1. Investing

    Elements of Insurable Risks: A Quick Guide

    Explore the elements of insurable risk: due to chance, measurable and definite, predictability, noncatastrophic, random selection and large loss exposure.
  2. Personal Finance

    Risk Management Framework (RMF): An Overview

    A company must identify the type of risks it is taking, as well as measure, report on, and set systems in place to manage and limit, those risks.
  3. Investing

    Methods of Handling Risk: A Quick Guide

    Discover the five methods to manage pure risk, and learn how they can be implemented to mitigate risk with health and life insurance.
  4. Insurance

    Explaining Insurance

    Insurance is a form of contract between an individual and an insurance company that spreads risk in exchange for premium payments.
  5. Investing

    Using Logic To Examine Risk

    Know your odds before you put your money on the table.
  6. Managing Wealth

    Why Companies Need Risk Management

    Implementing risk management strategies can save an entire organization from failure. Is yours up to snuff?
  7. Small Business

    Identifying And Managing Business Risks

    There are a lot of risks associated with running a business, but there are an equal number of ways to prepare for and manage them.
Frequently Asked Questions
  1. Where do most fund managers get their market information?

    Many fund managers, whether they manage a mutual fund, trust fund, pension or hedge fund, have access to resources that the ...
  2. What's the difference between short-term investments and marketable securities?

    Understand the difference between short-term investments and marketable equity securities, and learn the importance of short-term ...
  3. Are fringe benefits direct or indirect costs?

    Learn how to allocate costs associated with fringe benefits provided to employees and how to determine when a cost is either ...
  4. How is a bank guarantee different from a traditional loan?

    Read about the differences between a traditional bank loan and a bank guarantee, and why a third party might require a guarantee ...
Trading Center