What are Insurance and Insurable Risk?

Insurance is a financial instrument having legal validity. In this contract, there are two parties involved. The insurer and the insured. The insurance company or the insurer proposes to cover you financially in case of a loss arises. To ensure and continue this coverage you are required to pay small amounts every year, known as premiums.

Thus if an event for which you are covered occurs, you will receive an agreed-upon sum from the insurer or will be reimbursed for the losses depending on the type of insurance policy.

Thus the primary motive of insurance is to create a hedge against the risks associated with financial losses. An insurance policy helps to maintain economic sustainability. That is, it tries to bring you back to the same position, financially, as you were before the loss.

Insurance policies are of various types and cover a myriad of risks.

Types of Risk

A risk that meets the criteria of the insurance company and for which it can propose to cover is known as an Insurable Risk. Risks can be broadly classified into two categories,

1. Pure Risk

Risks that have no possibility of a financial gain, for example, fire, accident, etc

2. Speculative Risk

These are risks in which the outcome can be either positive or negative, eg, stock trading.

Generally, pure risks are covered by insurance, i.e., pure risks are insurable. For a risk to be insurable, insurance companies consider the following points.

a) Insurable risks should be financially large. That is, the risk must have high financial consequences.

b) The amount of risk should be predictable. The company should be able to know the frequency of the risk.

c) The loss should be measurable. Insurers must be able to quantify the loss.

d) The risk should not be in the control of the insured, it must be random or of chance.

e) An insurable risk is most likely to be common. This is done so that the insurer can create a pool.