THE CONCEPT OF RISK

DEFINITION OF RISK

There is no universally accepted definition of risk. It could be defined from any side or angle one is looking at it. Risk has been variously defined by different scholars.

Some of these definitions are:

1. Risk is a chance of a loss.
2. Risk is the probability or likelihood of an unfortunate event.
3. Risk is the potential that a chosen action or activity can lead to a loss.
4. Risk is the combination of hazards.

However, for the purpose of this post, the working definition of risk shall be referred to as “uncertainty of loss”.

In this definition, the situation may not be certain that it will happen but when it happens the end product must be loss. For example, there is no certainty of being robbed by armed robbers but one could still be robbed which will definitely result to losses.

 

CERTAINTY

Certainty deals with situations that will occur. An event is said to be certain if it involves unchangeable result. This situation is not contestable except that one is not sure of when it will occur. It is certain that everybody will die but the time and how it will come remain unknown to everyone. Likewise, it is certain that an increase in wage will increase employers’ expenditure and it is almost certain that if a student studies hard, he will pass.

 

UNCERTAINTY

Uncertainty refers to an event that will either occur or not. For instance, although death is certain, but when and how it will occur is unknown. Its effects on those left behind remains a problem that requires solution in terms of alternative to the deceased person’s financial responsibilities while alive.

 

CLASSIFICATION OF RISKS

It had earlier been emphasized that insurance deals with events whose results can be expressed in financial terms. Therefore future losses that are not capable of financial measurement cannot be insured. The following are the various classifications of risks that we have:

1) Pure risks: This type of risk relates to situations involving events that will definitely result to a loss if it happens and if otherwise, maintain its previous state of existence. For example, a building is exposed to a danger of destruction by fire. If the building is destroyed or damaged by fire, there is a loss, if not, nothing will happen to the building and it will remain in its state. Also, a vehicle on the road is not immuned from accident; rather it may be damaged or damage other person’s properties or incur a liability following an injury sustained by a victim or a vehicle snatched at gun point by a gang of armed robbers.

However the situation will be different if the vehicle returns home safely, because it will still maintain its previous state. Pure risk can arise from natural forces (i.e. acts of God or from the acts of men). They include events such as fire, flood, and accidental death, etc. These are risks which might normally bethe subject of insurance.

 

2) Speculative risks: Risk is said to be speculative if it involves a situation involving an event that has the characteristics of profit, loss or break even, the occurrence of which will lead to any of those stated outcomes.

Betting is a good example of speculative risk. Betting is speculation for gain, but a gambler may lose his stake, just recover his stake, or win more than his stake. Another example of this type of risk is retailing. Retailing is a speculative risk in the sense that goods can be sold at a price higher or less than the purchased price or sold at purchased price (gain, loss, breakeven). The above example shows that it involves the prospect of profit, loss or break-even. Thus any business entered into with the purpose of gain presents a speculative risk by the existence of the business.

 

3) Particular risks: This involves situations involving events caused by an individual with the aftermath effect directed towards the individual. It is a risk whose outcome is personalized. Examples of this type of risk are: theft of properties, professional negligence, and exposure to boiler, etc.

 

4) Fundamental risks: This is the type of risk that affects many people at once.

Unlike, particular risk that affects an individual, fundamental risk is a situation involving an event that is caused by the society we live in. Examples are unemployment, inflation and war. Such losses, when they occur, are impersonal because their effects are widely felt and not directed towards a particular person or group of persons.

 

5) Static risks: Static risks involve those losses that would occur even if there were no changes in the economy. Even if we could hold consumer tastes, output and income, and the level of technology constant, some individuals would still suffer financial loss.

These losses arise from causes other than the changes in the economy, such as the perils of nature and the dishonesty of some individuals. Unlike other risks, static risks are not a source of gain to society. Static losses involve either the destruction of the asset or a change in its possession as a result of dishonesty or human failure. Static losses tend to occur with a degree of regularity over time and, as a result, are generally predictable. Because they are predictable, static risks are more suited to be controlled by insurance than other risks.

 

6) Dynamic risks: It has recently been discovered that risk can change from one form to another. For instance, unemployment which was once regarded as a particular risk and considered to be caused by attitude towards work or lack of training on the part of individual concerned, is now classified as a fundamental risk because it is now believed that it occurs due to malfunctioning of economic system. Motor accident is another risk that is changing form in the sense that it is now caused by a combination of factors such as bad roads, poor traffic control, flooding and not as before when it was considered to be due to lack of driving experience (Particular risk).