There are mainly 2 types of risks in insurance that can be covered by insurance companies: pure risk and speculative risk. Under the two major risks other types of risks branch out. Insurance companies cover risks that are classified under pure types of risks in insurance. Speculative risks are not insurable.
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What Is Risk
Risk simply means a chance of occurrence of something which is harmful or unexpected that might result in loss or damage to valuable assets or to a person. This could also be danger, peril, hazard or any chance of loss due to negligence. Risk is never certain, and it is hard to predict, that is why insurance is essential. An insurance company assesses the various types of risks that are apparent to a business or individual and from there calculates the premium that the policy holder needs to pay.
Pure risk is one of the risks that can be directly linked to personal, property and liability risk. Pure risk simply refers to a situation that if damage is to occur then the outcome will lead to loss of a person or property completely or a break-even situation. The possibility of accidents in a factory, on the road or riots are classified under pure risk. A natural disaster is one of the risks that are pure in nature, where no one would profit from the event of a flood or an earthquake. Pure risk is a type of risk in insurance that is difficult to avoid and determine, however it can be insured against.
Of the 2 main types of risks in insurance, personal risk falls under pure risk. Personal risk refers to the individual. This risk is concerned with the health or safety of an individual. Accidents and illness are considered in this type of risk. Also, death, disability, retirement and unemployment are directly linked to personal risk. Personal risk can detrimentally affect the income earning capacity of an individual due to the sudden loss of financial assets or sudden death.
Property risk is the second type of risk in insurance that is classified under pure risk. Property risk refers to risk events that affect an organisation’s facility and other physical infrastructure. This includes anything that can cause a partial or total loss of property such as theft, fire or natural disasters. Property risk can stop a business from operating resulting in material and financial losses in addition to the damages they cause. Adverse weather conditions and terrorist attacks are also considered in this type of risk.
Another type of risk in insurance that is under pure risk is liability risk. This is personal or business risk associated with being liable to another party due to negligence or wilful acts that may cause a loss to another individual or another person’s property. For example, reckless driving or failure to perform contractual obligations. This liability risk is associated with legal liabilities to third parties.
Speculative risk is another major type of risk in insurance. This type of risk cannot be insured. Speculative risk means that if any damage is to occur the result may profit the individual, cause a loss or result in a break-even situation. Such risks are not insurable. Speculative risk is normally associated with trade. Buying shares in the stock market can result in profits, losses or neither due to the speculative risk inherent in that activity. Also, a company can incur losses due to a decrease in sales as a result of inflation. Speculative risk includes all investment and market risk.
Other classifications of risk in insurance
There are other ways risk in insurance can be classified. These classifications may affect all 2 major types of risk or just one of them. These types of risk in insurance are financial, non-financial, particular, fundamental, static and dynamic risk.
Financial risk is the type of risk in insurance where the outcome of an event can be measured in monetary terms. That is, any possible loss can be calculated and a monetary value determined. For example, the insured goods in a warehouse have a monetary value that in the event of theft or fire the value of goods lost can be paid out by the insurance company.
Non – financial risk refers to a risk where the outcome of an event cannot be measured in monetary terms. Such risks cannot be measured thus, they cannot be insured.
This type of risk in insurance arises as a result of the actions or interventions of an individual or a group of people. An accident is an example of particular risk.
Another type of risk in insurance that affects people and property mainly is fundamental risk. Fundamental risk is a type of risk that the individual has no control over. Such risks are said to be impersonal in their origin and consequences. Also, the impact of fundamental risk can affect the rest of the population. Natural disasters and recessions are good examples of fundamental risks.
Static risk is the kind of risk that remains constant over time. Such risk results from human mistakes or actions of nature. For example, employee dishonesty or the embezzlement of funds in a company by one the employees. Static risk can be measured easily and is insurable.
Dynamic risk arises due to changes in the economy. Such changes are not easy to predict and may bring about financial losses. Such changes include a global pandemic, changes in the income levels, tastes and preferences of individuals. Dynamic risk is difficult to measure and insure.
The importance of insurance cannot be overemphasised. Doing business on its own is a risky venture and life in general is full of uncertainties for any individual. The various types of risks are a part of life and business and should be managed appropriately. Managing all types of risk in insurance will enable a person to protect him/herself, the business and one’s family as well as manage costs during a recession and difficult times.