Characteristics of insurable risks

Characteristics of insurable risks

What are the characteristics of insurable risks?

In order for a risk to insurable, its potential loss must have the following characteristics:

  • The loss must occur by chance;
  • The loss must be definite;
  • The loss must be significant;
  • The rate of loss must be predictable;
  • The loss must not be catastrophic to the insurer.

The loss must occur by chance

To be insurable, the potential loss of the risk should be unexpected, unforeseeable and not intentionally caused by the insured, For example, the risk of a person being killed in an accident is fortuitious and is beyond the control of that person; hence, insurance companies can offer Personal Accident Policies to provide economic protection against fincial losses caused by such accidents.

 

The loss must be definite

The potential loss of an insurable risk must be definite in terms of time and amount. An insurer must be able to know when to pay a claim and how restricted is the period of cover granted to the insured. Therefore, he would expect   to pay for losses which have occurred during that period.

The amount of claim to be paid depends on the type of insurance contracts issued. Basically, there are two types contracts of indemnity and valued contracts. A contract of indemnity is one in which the amount of claim is based on the amount of financial loss as determined at the time of loss, subject to the maximum sum insured stated in the policy. Most general insurance policies are contracts of indemnity. For example a fire insurer would indemnify the insured based on the actual property damage and losses caused by the insured perils. The insurer would pay up to the amount of the sum insured; the insured would bear the balance should the losses exceed the sum insured.

A valued contract is one that specifies in advance the amount of compensation that will be payable when a total loss occurs. The value is agreed between the insured and the insurer at the inception of the policy. If a total loss occurs, the amount payable is the sum insured. Valued policies are commonly issued for items such as paintings, sculptures, antiques and items of jewellery. For the sum insured to be agreed at the time of effecting the policy, a professional surveyor is normally engaged by the insurer to assess the value of the item to be insured. Examples of valued contracts are All Risks Insurance ( for the policy holders ), Personal Accident Insurance, and most Life Insurance Policies, such as Whole Life, Endowment, term etc.

The loss must be significant

It is common for people to lose things like umbrella, key pouches, pen, pencils and sunglass. Such losses are not apt to be very significant financially. Replacing an umbrella does not cause financial hardship to most people. These types of losses are not normally insured as the administrative cost of handling such small claims could be so high as to lead to increased cost for such insurance protection and most people would find the protection uneconomical. On the other hand, some types of losses could causes financial hardships to most people. For example, a fire gutted a row of residential housing. The resulting home loss would be significant to the residents.

 

The rate of loss must be predictable

To provide compensation in the event of a specified loss, an insurer must be able to assess the chance of loss occurring or predict the probable rate of loss. These predictions of future losses would enable the insurer to determine the proper rate of premium to charge each policy- holder to ensure that insurers have adequate funds to pay claims as they become due.

 

To predict the probability of loss, insurers use statistical analysis of past and current data gathered from various sources. Insurers also apply an important concept ‘ law of large numbers’ to determine the loss probability. According to the law of large numbers, the larger the number of observations made of a particular event, the more likely it will be that the observed results will produce an estimate of the” true” probability of the events occurring. By using the law of large numbers, insurers can predict fairly accurately the number of future losses that will occur in a similar groups or units of exposures.

 

The loss must not be catastrophic to the insurer

Where the large numbers of people are subject to heavy risks or where there is a concentration of risks, the resultant potentials losses could cause or contribute to catastrophic financial damage to the insurer. Such risks are not insurable as the principle that the losses of a few are borne by the contributions of many cannot be applied here. Moreover, the losses could be too excessive and the insurer’s accumulated insurance funds may not be sufficient to support them. For example, property damage caused by war. In such cases, governments often accept responsibility for these risks.  

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