Insurable Risk

Insurable Risk Definition 

Insurable risks, as the term specifies, are those risks that insurance companies will cover. Some common examples include health issues, danger to life, fire, perils of the sea, etc. These risks must satisfy certain conditions to become insurable so the insurer isn't placed in an unfair position.

Insurability is an essential component of any insurance policy. Some of the features of insurable risk include definite proof of loss, measurable risk, non-catastrophic nature, affordable premium, calculable, accidental, and large loss, etc. These factors play an important role in insurance claims and premium payments.

• Insurable risk can be defined as the risks that can be protected under insurance coverage. These are the most common type of risks. 
• Risks to health, life, identity, property, investments, etc., are all insurable. 
• Risks are either pure or speculative. The former is insurable, and the latter is not. Pure risks are further classified into personal, property, and liability risks based on the insurable interest.
• Features of insurable risk include measurability, definiteness, accidental and non-catastrophic nature, statistical probability, etc.

Insurable Risk Explained

Insurable risks are those contingencies insurance companies will cover. This tells us that there are some risks that insurance companies do not cover. There are many risks an individual undertakes in a single day. But it is impossible to pay premiums on those risks and make claims when things go wrong.

So, why do some risks go uninsured? Let's consider two perspectives here – the insurer and the insured. An insurer often deals with many customers with multiple concerns – health, life, car, house, business, theft, etc. These are all insurable in most cases. However, consider a recurring event that poses damages and loss to a particular property. 

For example, an earthquake occurs every month. Each time, the owner claims at least $1000 for the damages while paying a monthly premium of only $200. The insurer loses more, which will be significant in the long run. There are many such situations that an insurer would like to assess before they insure a risk. Thus, they abstain from frequent and expensive risks.

From the insured's perspective, high risks attract a high premium. Thus, even if an insurer is ready to undertake a risky contingency, the insured would have to pay a high amount towards the policy. This would be disadvantageous for the insured.

Most risks are of two types – pure and speculative. Pure risks are those subject to uncertainty and carry a genuine probability of financial loss with zero probability of financial gain. Car accidents are a suitable example. Speculative risks, on the contrary, have an almost equal probability of profit and loss, like gambling, for instance. Thus, pure risks are insurable risks, whereas speculative risks are non-insurable.

Characteristics

By now, it is understood that not all risks are insurable. So, let's study the elements of insurable risk.

• Accidental in nature – A contingency that has occurred should be beyond the insured's control. To the best of their ability, the insured should take all the precautions to avoid such an event. For example, if a nuclear power plant has a 90% chance of explosion, no insurer will step in to insure it. On the contrary, a plant with a maximum 5% chance of explosion can be insured, provided the insurer is convinced that all steps are being taken to avoid a mishap.
• Definiteness – Any loss should be attributable to a cause, a specific time, and a place. For the insured to assert their claims, solid proof of loss is necessary. For instance, a construction worker has lost her life while on duty. The definite time of her death is known, and there are ample witnesses to the accident. Thus, her dependents can claim life insurance.
• Measurability – The insurability of risk depends on the extent of the loss. A calculable loss makes it easier for the insurer to determine premiums and the claim amount. Consider this example. Ryan buys an auto insurance policy for $10,000. He has to pay a $250 premium every month. If his car is totaled, he will receive $10,000. He can claim the insurance depending on the loss estimated by his car company.
• Non-catastrophic in nature – Insurance companies do not usually insure catastrophic risks that are usually unforeseen or cannot be precisely predicted. Here's an example. There is a dormant volcano on island X. It last erupted around 1000 years ago. However, one day, the volcano erupted unexpectedly due to climate changes. Many people lost their lives and property. But this is not an insurable risk.
• Large loss – The financial loss incurred by the insured should be large enough from the individual's perspective. This necessitates an insurance policy should any significant event arise for the insured. Therefore, insurance of $500 on a car might not seem practical. 
• Statistical probability – Any contingency should be statistically predictable to become insurable. This helps in the determination of premiums. For instance, highly probable events will attract high premiums.

Types

There are three major insurable types of pure risk:

1. Personal risk – This involves the risk to human life and health. It can also mean a risk to identity or financial investments. Other personal risks include unemployment, bankruptcy, identity theft, accidents, etc.
2. Property risk – Any risk to an individual's property like a house, automobile, business, etc. Theft, fire, and explosion are some examples. 
3. Liability risk – A liability risk holds a party (the insured) responsible for certain risks or losses to other parties. For example, a car accident where the other person is injured or the car is totaled. 

Examples

Check out these examples to get a better idea:

Example #1

Jacob buys a house in a neighborhood prone to natural calamities like landslides and earthquakes. He wasn't aware of it during the purchase. But later, he could not insure his house as no insurance companies wanted to cover the house. Finally, Jacob was ready to pay higher premiums. However, no insurers agreed, and the house became uninsurable.

Example #2

The chief executive officer of one of Europe's biggest insurance companies, Zurich, recently remarked that cyber-attacks would soon become uninsurable. This is due to the high frequency of these claims and the huge amount at stake. Cyber-attacks can dismantle companies' infrastructure, leading to significant losses that the insurance sector cannot undertake. Catastrophe-related claims have topped the charts for two years, estimated at $100 billion in 2022. 

Difference Between Insurable And Non-Insurable Risk

• The main difference between insurable and non-insurable risks is that insurance companies cover the former while they do not cover the latter.
• Non-insurable risks can become so if they do not satisfy the requirements of insurable risks – measurability, definiteness, accidental and non-catastrophic in nature, large loss, etc.
• The reason is that non-insurable risks may become too risky for the insurer. Therefore, insurers try to avoid insuring such risks if the probability of occurrence is too high or the claim amount can be significant.
• However, insurers try to cover more risks with higher premiums and stringent procedures during claims. Yet, some risks almost always fall outside their scope.
• Also, it is not practically possible for insurers to go about insuring all the types of risks on the planet. After all, insurance is a business for many, and they try to avoid losses.

Some examples include pandemic risks, political risks, a risk to reputation, trade secret risks, etc.

Frequently Asked Questions (FAQs)

Recommended Articles

This has been a guide to Insurable Risk and its definition. Here we explain its characteristics, types, and examples and compare it with non-insurable risk. You can learn more about accounting from the following articles –

• Personal Property Insurance
• Insurance-Linked Securities
• Business Insurance