Risk is a hazard, loss, danger, and any unforeseen adverse event that causes harm to humans, properties, equipment, and even animals. It is also an unplanned event that occurs, which causes significant economic consequences that translate to loss. In any financial institution or activity, the higher the profit, the more the chances of risk. Therefore, whenever there is a significant profit, there is a risk, which increases the importance of insurance.
The purchase of insurance policies is an example of risk management. The insurance policies are used to minimize the effect of risk as much as possible. However, to properly manage risk, it is crucial to understand the risks before appropriate insurance measures can be taken.
It is essential to analyze your risks and take measures to reduce the chances of occurrence of risks before deciding the insurance you’d like to purchase. Also, in the event of a risk, it is crucial to take appropriate steps to prevent a considerable impact on your life.
There are six types of risks, which are:
Pure risk is the type of risk that has a familiar outcome, which is a loss. Whenever this type of risk occurs, the outcome is always negative or always leads to loss. An example of pure risk is a fire outbreak in a household or any natural disaster. It also covers unpredictable events, like terrorist activities, theft, etc., whose ultimate outcome is loss. Humans do not have any control over such risks and never lead to any financial gain.
Another example is a car getting into an accident. In most cases, all pure risks are eligible for insurance cover. One characteristic of pure risks is that they are measurable, therefore, insurable.
Pure risks are of three types – Personal, Property, and Liability.
This type of risk doesn’t have a predictable outcome. Therefore, speculative risks are not insurable. These types of risks occur due to human actions and can lead to either profit or loss. They are considered to be controllable risks and depend on the decisions of a person. All financial investments come under this type because they rely on the choice of a person.
They include credit sales, marketing, pricing, and more. An example of speculative risk is the pricing of stock of a company, which is speculative and unmeasurable. Therefore, speculative risks are not insurable in most cases.
This risk is an incident that causes loss that can be quantified in terms of money. This means that money can be given when such a loss occurs. An example of financial risk is the theft of a set of expensive jewelry. Money can be provided in place of the stolen jewelry. Since financial risks can be replaced, all of such risks are insurable. Concerning death as a risk, significant financial support can be offered to the family.
Non-financial risk is the type of risk where the result is not measurable from a monetary perspective. This type of risk mainly constitutes making a wrong choice or disliking the outcome of such a choice. An example of such a risk is deciding on the size of a house to purchase. Therefore, non-financial risk is not insurable.
A fundamental risk is the type of risk that mostly occurs naturally, and affects a large population within society. This type of risk is beyond human control.
Examples of fundamental risks include earthquakes and floods. It also includes events such as war or inflation. Initially, fundamental risks were not insured. The demand for such type of coverage for naturally occurring risks has made it insurable.
This type of risk occurs as a result of human activity. It mostly occurs due to human error or negligence. Examples of particular risks include burglary and loss of shipment. Particular risks are the most insured type of risk.
The shift of risk involves the transfer of risk from an individual or an organization to an insurance company. The insurance company covers the loss in case of any unforeseen event. The shift of risk as a form of risk management involves the transfer of liability under a specific agreement between parties. Liabilities are mainly all types of risks that are insurable by insurance companies.
Companies or organizations that are willing to take excessive risks for more profit and increase their shareholders’ income, transfer their additional risks to the insurance companies so that the impact of an unsuccessful venture doesn’t put much pressure on the organization.
The shift of risk is vital as it allows individuals and organizations to perform their daily activities without the fear of losing their livelihood or business, which is only possible when some form of insurance exists.
Risk Calculation is done by combining the probability factor of an event and the consequences that the event can bring with it. Although the calculation of risk and probability is sometimes tricky for many people, it is, however, the cornerstone of insurance companies’ operation. Therefore, the insurance sector consists of individuals that know how to compute risk and make essential conclusions over time.
In calculating risk, insurance companies consider all possible dangers that may exist. The amount of premium that a client pays must cover the damage that may occur and still provide sufficient profit to the insurance company. Catastrophe modeling is used by insurance companies to forecast the probability of a risk and the cost of repair or replacement. It also helps the insurer to determine the rate of premium per assurer.
For instance, for a company to calculate the likelihood of flood destroying a house, it uses the historical flood data of the location in question. This data is inserted into the model, and thousands of scenarios are simulated, which ranges from disastrous to favorable values. These values ultimately determine the premium the assurer pays. Additionally, apart from the worth of property and content, the insurance company’s expenses are considered in determining the premium to ensure the right profit margin.
The catastrophe modeling method used can vary from one insurer to another, which may also change the amount of premium paid by each assurer. Also, insurers usually incorporate the likelihood of assurers filing for a payout, which in many cases relates to the factors that affect the location of properties or equipment.
Therefore, the premium paid against flood for a house close to the sea would be higher than the one that is a thousand kilometers away. Also, insurers consider the condition of properties or equipment of assurers when determining the premium rates to establish the possible payout sum and the level of risk involved.
Risk for a business can occur due to certain internal events like bad management decisions, employees’ mistakes, or improper accounting policies. There are some external factors also, which can be considered as a risk for companies. Certain risks like the burning of company assets are given more priority over other risk factors.
Car insurance firms consider several factors when determining the risk of an assurer. The crucial factor that affects risk is the type of vehicle to be insured. The cost and the model of a car are also of importance when determining risk. Fast cars would generally have higher premiums than slower cars.
Next, personal circumstances and driving routines of an insurer are considered. Personal circumstances such as age may drive the premium rates higher or lower.
For example, younger people tend to pay higher as they get into more accidents. Also, drivers that have a higher number of accidents in the past would tend to pay more. Furthermore, the number of driving hours of a driver may affect the premium rates.
Finally, the financial status of an assurer is essential. Insurance companies try to scrutinize the financial position of an assurer to determine the level of risk, which leads to the determination of premium rates.