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INSURABLE AND UNINSURABLE RISKS

MEANING OF INSURABLE RISK

Insurable risks are those risks accepted for an amount by an insurance company followed with a promise to make financial compensation available to those that experience the losses. This type of risk is the one in which the chance of occurrence can be deduced from the available information on the frequency of similar past occurrences.

 

INSURABLE RISK IN PROPERTY

The chance that a certain vehicle will be involved in an accident in the year 2012 (out of the total number of vehicles insured in 2012) can be determined from the number of vehicles that were involved in an accident each year in the recent past.

 

INSURABLE RISK IN LIFE

The chance that a man or a woman of a certain age will die in a given year can be estimated by the fraction of people of that age that died in each year in the recent past.

For a risk to be insurable, several things need to be put in place, such as:

  1. The insurer (insurance company) must be able to charge a premium high enough to cover not only claim expenses but also the insurer expenses. In other words, the risk should not be so catastrophic or large that the insurer will not be able to pay for the loss.
  2. The nature of the loss must be definite and financially measurable. There should not be room for argument or as whether payment is due or not, nor as to what amount the payment should be.
  3. The loss should be random in nature, else the insured may engage in adverse selection.
  4. There must be large number of similar risks. It needs to be said here that sufficient large number of similar risks gives a high degree of accuracy in determining the probability of loss.
  5. Pure risk only: The insurance company will only accept risk that involves situation that could lead to loss or in the absence of the loss, maintain it same position. The type of risk that suites this is pure risk. Although this is not to say all pure risks are insurable. The main reason for speculative risk not being insurable is the aspect of gain which is contrary to the principle guiding the practice of insurance with regards to claims settlement. Indemnity ensures exact financial compensation for actual loss suffered and not to make profit out of the loss.
  6. Particular risk: Particular risks are insurable provided they satisfy other criteria for insurable risks.
  7. The insurable risk must involve element of uncertainty resulting to financial loss. The situation must not be in control of the person seeking for insurance protection.
  8. Insurable interest: In insurance contract, it is very essential that the person proposing for insurance must stand with relationship with the subject of the insurance so that the insured will directly suffer financial loss by its destruction or damage by the insured events, while he benefits from its safety and well being. For example, a car owner deprived of the use of his car by accidental fire or by theft would personally require the financial succour for him to be back on the road. The essence of insurable interest is to discourage the placement of risk by someone else other than the rightful owner of the property. In a situation whereby the person seeking for insurance protection has no financial relationship with the subject of the insurance,the insurance contract is void.
  9. Reasonable premium: The premium to be charged must be commensurate with the risk and must be reasonable.

 

MEANING OF UNINSURABLE RISK

This is the type of risk which the insurer (insurance company) is not ready to insure against simply because the likely future loss cannot be estimated and calculated. It holds the prospect of gain as well as loss. The risk cannot be forecast and measured. Uninsurable risks are those that fall within the definition of speculative risks and fundamental risks which have to do with situation centered by the society we live in. Examples are:

1) Act of God: All risks involving natural disasters such as:

  • Earthquake.
  • Tsunami.
  • War.
  • Flood.

It is important to note that any building, property or life insured but lost during an occurrence of the act of God cannot be compensated by an insurer.

 

2) Gambling: You cannot insure your chances of losing gambling game.

 

3) Loss of profit through competition: You cannot insure your chances of winning or losing in a competition.

 

4) Launching of new product: A manufacturer launching a new product cannot insure the chances of acceptability of the new product since it has not been market- tested.

 

5) Loss incurred as a result of inefficient management: The ability to successfully manage an organization depends on many factors and the profit or loss depends onthe judicious utilization of these factors, one of which is efficient management capability. The expected loss in an organisation as a result of inefficiency cannot be insured.

 

6) Poor location of business: A person situating a business in a poor location must know that the chance of its success is slim. Insuring such business is a sure way of duping insurer.

 

7) Loss of profit as a result of fall in demand: The demand for a product varies with time and other factors. An insurer will never insure based on expected loss due to decrease in demand.

 

8) Opening of a new office: This is considered non- insurable risk. One does not know what to expect in the operation of the new shop, and it is illogical for an insurer to accept insuring a new office.

 

9) Change in fashion: Fashion is a trend which cannot be predicted. Any expected change in fashion cannot be insured. A fashion house cannot be insured because of component of the fashion house may become outdated at any point in time.

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