Benchmarks for Insurable Risks
People insure against their risks because
they know there are possibilities of losses. It is quite assumable that
not all risks are insurable, including pure risks. There are certain
criteria in an insurable risk. We need to differentiate these two
different concept: True
insurance and special arranged insurance.
When famous
footballers
insuring their legs and famous actors insuring particular
parts of their body for significant amount of money, we can say they
are insured under "specially arranged insurance" and not
"true insurance".
These types of risks are usually underwritten by some huge
underwriting groups. Special techniques are used to determine the
premiums for the potential losses.
In practice, only those risks that meet the following requirements
are considered insurable risks:
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The loss is sufficiently certain for a monetary value to be
determined, for example the keyman of a firm can be valued by his job
performance.
The basic nature of insurance is to conduct itself as a risk
transfer device and thus furnish financial compensation for loss.
You will note that insurance does not eliminate the risk, but merely
provide financial protection against the consequences. This being
the case, the said risk that may result in a loss must be capable of
being ascertained in financial terms, i.e. it must have a financial
value.
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The loss is not exceedingly catastrophic in size,
for example insuring
the whole population against war losses.
This factor basically means that an exceedingly large proportion of
exposure units should not incur losses at the same time. As
mentioned earlier, pooling is one of the essences of insurance. If
for some reasons, most or all of the exposure units in a certain
class simultaneously incur a loss, then the pooling concept is
defiled and turns impracticable. To maintain the feasibility of
insuring the class of people, the insurer may have to raise premiums
rate to a prohibitive level, and the insurance of spreading the risk
of loss of a few over an entire group becomes not feasible.
Ideally, insurers would want to avoid all catastrophic losses, but
this is unrealistic. A plane accident can cost insurers millions in
compensation payments. Fortunately, there are available remedies for
the insurers in facing catastrophic losses.
One commonly used is reinsurance. Essentially, reinsurance is
shifting of part or all of the risk originally underwritten by one
insurer to another insurer called the reinsurer. Once the risk is
reinsured in this manner, the reinsurer concerned is now responsible
for his share of the loss.
Another way insurers can avoid the concentration of risk is by
dispersing their coverage over a large geographical area. This
dispersal of coverage will ensure the insurer's fortune is not wipe
out by catastrophic losses that resulted from severe climatic or
other occurrences that happened in a particular geographical area.
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The loss is not something that is definite to happen,
which means it must
be fortuitous.
A fortuitous loss is something that is
unpredictable, cannot be foreseen and happens purely by chance. From
the insurer standpoint, it is simply not possible to insure against
an event which will definitely occur, since it involves no
uncertainty of loss and therefore no transfer of risk would be
taking place. It is another way of saying the loss is purely accidental for insurance
coverage to be possible. This would
cut off definite events such as damage caused by wear, tear or
depreciation and those that are inflicted voluntarily and
intentionally by the insured or someone hired by the insured. Even
though death of a person is certain, life insurance works within
this principle because the timing of death is fortuitous.
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The possibility, magnitude and vacillation of future losses must be
mathematically predicable, which means the happening can be determined
through calculation.
For a risk to be insurable, the chance of loss should be calculable.
The insurer must be able to mathematically determine both the
average severity and the average frequency of future losses with
some degree of accuracy. Otherwise, a proper premium cannot be
charged to cover all future claims, cover all expenses and still
make a profit at the end of the day.
The reason why certain risks are difficult to insure is precisely
because the chance of loss is difficult to calculate, and the
possibility of a catastrophic loss is in place. Examples of such
risks are wars and earthquakes.
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The quantum of loss must be consequentially acceptable to the
extent that the sum of future compensation to an insured is not a
dominant part of the charge collected from him, which means the face amount
of the insurance must be far in excess of the premium paid or to be
paid.
To insure a risk, the premium charged must make sense economically.
The amount charged to insure an individual must be a sum that the
insured can afford to pay. Furthermore, the premiums paid must be
substantially below that of the policy face amount or else it would
not make sense to purchase the cover.
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The person insuring against the loss must have a legal standing to
insure the subject matter, for instance insurable interest.
It is mentioned earlier that one requirement of an insurable risk is
that there must be some losses which can be measured in financial
terms. Common sense will tell it is easy for a person to insure the
property of someone else in anticipation of it being lost or
damaged, and then to make a profit out of the "investment". In this
case, there would be a financially measurable loss that fall within
the context of what is a requirement of an insurable risk. However,
this is not acceptable in law. For a risk to be insurable, there
must be a recognizable relationship between the insured and the
financial loss, which means insurable interest must be present. The concept
of insurable interest has been quite adequately discussed in the
earlier part of this chapter, and the reader should refer back to
reinforce understanding of the concept.
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Insuring the loss must not be considered to have violated any law
or gone against public interest, for instance insuring against a hefty speed
fine.
Again, it is a practice in law that that court will not support an
illegal contract, which would be the case if insuring a risk go
against any law or is against public interest. Henceforth, insuring
a loss that is created by the insured, for instance, will not be
allowed.
For those risks that do not meet the
above requirements, they are uninsurable.
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