Insurance is a risk management tool that enables individuals and enterprises to better protect themselves from financial losses resulting from unforeseen events. However, not all ‘risks’ are eligible for insurance. In fact, insurance companies meticulously examine the risks that they are willing to cover. There are three primary types of risks in insurance – financial and non-financial risks, fundamental and particular risks, and pure and speculative risks. Interested to know more in detail? Read ahead!
What are Financial and Non-Financial Risks?
To begin with, financial risks are the type of insurance risks whose outcome can be valued in monetary terms. These include risks such as loss of income, property damage, liability claims, etc, as they can be adequately and thoroughly assessed and can be assigned with a monetary denominator. Financial risks can be remedied and are usually insurance. The common contexts that qualify to be a monetary risk are –
- Material damage to property resulting from a natural disaster or accident. So, instances like damage to a ship due to a cyclone or the destruction of a car in an accident are financial in nature.
- Theft of a personal item, such as a motorbike, machinery, or even household items and cash is another example of financial risk.
- Loss of profit in a business due to fire is also a financial risk.
- Personal injuries owing to accidents that culminate in medical expenses, court lawsuits, etc, are also financial risks.
- The death of a breadwinner in a family that leads to a consequent financial hardship is also a financial loss.
All the risks mentioned above are the outcome of unforeseen untoward incidents and can be weighed in monetary terms. These losses may be made whole, restored, or replaced, or even a matching financial assistance can be provided (for instance, in case of a death).
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Thus, there are financial risks that are insurable as well. In fact, these risks are the primary subjects of most insurance policies.
On the other hand, non-financial risks are the risks whose outcome cannot be measured in monetary terms. These risks include regulatory risk, reputational risk and strategic risk. Non-financial risks usually arise due to a wrong decision or a faulty choice, resulting in a possible discomfort, disliking or embarrassment but there is no valuation in tangible terms. Thus, non-financial risks are uninsurable as an insurance company finds it challenging to quantify and manage them.
Some of the common examples of non-financial risks are –
- Selection of a restaurant menu
- Career choice
- Choice of car, its brand, color, etc
- Choice of publicity
What are Pure and Speculative Risks?
Pure risks are the types of risks whose outcome results in loss only or, at best, a break-even situation. Such situations or outcomes do not have scope for any kind of gain, no matter how minuscule. The consequence of a pure risk is always unfavorable or may be the remains the same as before sans any profit. Pure risks are usually insurable and can be measured in tangible terms.
Some of the common examples of pure risks include –
- Cyclone damage to a factory or home
- Fire damage to a home
- Breakdown of machinery in a factory due to a storm
- Theft of items from a factory
- Personal accidents and injuries of workers in a warehouse
The contexts mentioned above have an associated loss arising out an unforeseen event or contingency, such as a fire, cyclone or theft. These are, thus, pure risks and are insurable. It is noteworthy to mention that these pure risks can also be valued in monetary terms.
On the other hand, speculative risks are the type of risks whose outcome can either come with a gain or loss. These risks are usually not insurable, as they come with a positive and negative consequence. Some of the common contexts of speculative risks revolve around marketing, forecasting, pricing, investing, etc.
Some examples of speculative risks include –
- The changes in fashion trends because of which demand for a specific falls drastically
- The question of credit sale
- Loss incurred in stock investment
Speculative risks, such as the ones mentioned above, are not the outcome of pure risks but economic factors, such as supply and demand, trade restriction or liberalization, change in the fashion cycle, etc. Thus, they are called trade risks and cannot be insured.
What are Fundamental Risks and Particular Risks?
Fundamental risks are the risks caused by natural events. They usually arise out of reasons that are beyond the control of an individual or group of individuals. Such losses can be catastrophic in their proportion and experienced by a large number of people, the society, or by the state. However, an individual can also be a part of the catastrophic.
The common examples of fundamental risks are –
- Floods and cyclones
- Landslip and subsidence
- Drought and other natural disasters
Moreover, perils like war, terrorism, riots, etc, can also be considered as fundamental risks, despite being man-made, as the result and outcome of such events is always a massive loss of life and property. However, the common denominator of such risks is that they are impersonal and not caused by an individual or targeted towards a singular person. Earlier, fundamental risks were not deemed insurable because of the colossal magnitude and the remediation responsibility was given to the state. However, no, such risks are insurable.
On the other hand, particular risks are risks that result from actions of a single individual or a group of individuals. They are mostly man-made perils occurring due to error in judgment, negligence, carelessness, disregard of law, etc. Some of the common examples of particular risks are –
- Motor accidents
- Industrial accidents
- Collapse of bridges
Particular risks are insurable risks and most policies revolve around these circumstances.
Wrapping It Up
So, there we have it, a crisp overview of the 3 types of risks in insurance. However, it is essential to remember that risk in insurance is a dynamic concept and can be modified based on the situation.