Why every risk is not insured
Insurance companies do not cover all risks. That is to say, all risks are not insurable. Usually it is only the ‘pure’ risks which are insurable and not the ‘speculative’ risks. A pure risk can cause only loss but a speculative risk causes either a profit or loss. For example, there is risk in any investment and business venture due to market fluctuations This is a speculative risk and, therefore, not insurable. However, a business man can insure the assets and legal liabilities against specified perils like fire, flood, cyclone, negligence, collision etc. However all pure risks are not insurable as there are many situations that can cause loss where the law of large number does not operate satisfactorily. For many situations large number of required statistical records are not available. If the insurers can not obtain statistics over a sufficient length of time on losses resulting from a particular peril, they can not accurately predict the probable loss experience. In that situation it is not prudent to cover such risk. So it is evident that the prime requisite of insurable risk is that the number of objects must be of sufficient number. This means the probable loss must be subject to advance estimation in order that it can be made accurate the objects to be insured must be similar so that reliable statistics of loss can be formulated.
For example. in case of fire and theft insurance, commercial buildings and private dwellings should be grouped separately as the hazards against these risks are different. Similarly, the properties situated in the cyclone belt should not be grouped with that of the properties located in the cyclone free zone. This means the physical and social environment of the group ought to be roughly similar. Therefore, it is evident that from the view point of the insurer one of the prime requisites of insurable risks is that the number of objects must be sufficient in number and quality so that a reasonably close calculation of probable loss can be made. Therefore, the insurers cover those risks which are pure and where the law of large number can be applied satisfactorily to measure the risks involved.
All risks are not insurable. This is mainly because there are many risks which in the true sense can not be termed as risks. Therefore, the authors of risk management have differentiated between pure risk and speculative risk. Normally the pure risk is insurable and speculative risk is handled by methods other than insurance. In pure risk, there is uncertainty as to whether the loss will occur or not but there is no chance of producing profit out of that event. But in case of speculative risk there is uncertainty of an event which could produce either a profit or loss. For example, a business venture and a gambling contract are the risks of speculative nature and therefore not insurable. Market risks such as price changes and or changes in the exchange rate of currency are not insurable. These risks are not subject to advance calculation, hence the insurer would have no realistic basis for computing his premium.
Further, in times of rising prices no one would be interested to have insurance coverage against such risk and in times of falling prices an insurer can not afford to take on the risk because he can not avail the opportunity of spreading the risk over which to average out good years with bad years. The speculative risks are handled by the businessman by way of hedging, whereby a speculator assumes the price risk.