It is very difficult to provide a single, comprehensive definition of risk, but the following list gives some possible definitions:

• Risk is the doubt concerning the outcome of a situation.
• Risk is uncertainty as to the occurrence of a loss.
• Risk is unpredictability.
• Risk is the chance of a loss.

Categories of risk

Not every risk is insurable. We need to look at those types of risk that are insurable. We are looking only at general insurance. Insurable risks can be grouped as follows:

• financial risks;
• pure risks; and

particular risks

Financial risks

For a risk to be insurable, the outcome must be capable of measurement in monetary terms. In other words, there should be some kind of value attached to the risk in question. The term ‘financial risk‘ relates to the outcome rather than the nature of the risk itself.

Examples

• Accidental damage to a motor car. The financial value of the risk is the cost of repairing or replacing the vehicle.
• Theft of property. The financial value of the risk of theft of a television is its current market value.

Pure risks

Pure risks are those where there is no possibility of making a profit. The best that can happen is to break even and there is the possibility of a loss (even if a loss is fully covered, there may still be payment of an excess).

Examples

• The risk of a motor accident. The owner is in a worse position if damage occurs and is in an unchanged position if no accident occurs.
• A fire at a factory. The owner would suffer loss if the contents of the factory were destroyed or damaged but no loss if there were no fire.

Particular risks

• Particular risks are personal or local in their effect. They arise from causes that affect individuals or local communities in their consequences.

Examples

• A fire can happen when, for example, machinery overheats and can result in lost stock and, possibly, lost profit. The fire may spread to the building next door. The owners of the lost stock and damaged building are affected by the fire.  If a theft happens, the result affects only the victim who is deprived of something they own.

                  Types of risk which can be insured

For a risk to be insurable, the following features must be present:

• The event insured against must be fortuitous
• There must be insurable interest
• Insuring the risk must not be against public policy

Fortuitous event

To be insurable, the happening of the event must be accidental and not inevitable. It must not be within the control of the insured. The event must be unforeseen and therefore fortuitous so far as the insured is concerned.

Consider this…

Two flats are burgled within the same week. The first flat was properly locked and the burglar managed to force open a window in order to steal contents from the flat. The second flat had keys left in the door and several large windows open, which allowed the burglar to enter the property and steal the contents. Which of these two losses could be described as fortuitous? Which of these losses are likely to be paid by insurers?

Insurable interest

This is the legally recognised relationship between the insured and the financial loss which the insured suffers on the happening of an insured event. You can insure the risk of theft of your own car, because you suffer a financial loss if it is stolen.

Public policy

It is commonly recognised in law that contracts must not be against public policy or go against what society considers to be the right moral thing to do. Insurers will not, therefore, cover risks which are against public policy. For example, it would be against public policy to insure the risk of incurring a fine for a criminal offence such as speeding. If you were able to insure against these events, it would encourage the public to break the law.

Homogeneous exposures

Given a sufficient number of exposures to similar risks, the insurer can forecast the expected frequency and likely extent of losses. This is achieved by using the law of large numbers, a theory that determines that predictions become more accurate as the base of data to which assumptions are applied increases in size. This theory is investigated in more detail in Law of large numbers on page 2/9. In the absence of a large number of homogeneous exposures (similar risks), the task is more difficult, as patterns and trends are more difficult to determine.

Whereas fortuitous loss, insurable interest and not being against public interest are absolute requirements for a risk to be insurable, the concept of homogeneous exposures is an ideal and there are occasions when an insurer will need to use less than fully reliable historical data when fixing premiums.