Meaning of Risk
There have been many attempts to define ‘risk’.
Probably, to most of us, ‘risk’ contains a suggestion of loss or danger.
We may therefore define it as ‘uncertainty concerning a potential loss’,
a situation in which we are not sure whether there will be loss of a certain
kind, or how much will be lost. It is this uncertainty and the undesirable element
found with risk that underlie the wish and need for insurance.
The potential loss that risk presents may be:
(a) financial: i.e. measurable in monetary terms
(e.g. loss of a camera by theft);
(b) physical: death or personal injury (often having
financial consequences for the individual or his family); or
(c) emotional: feelings of grief and sorrow.
Only the first two types of risks are likely to be
(commercially) insurable risks. Also, from a wider perspective, not
every risk will be seen in the negative form we have just outlined.
Note: Without trying to
complicate matters, we should also be aware that insurance practitioners may
use the word ‘risk’ with other meanings, including:
1. the property or person at risk that they are insuring
or considering insuring; and
2. the peril (i.e. cause of loss) insured (so,
some policies may insure on an ‘all-risks’ basis, meaning that any loss
due to any cause is covered, except where the cause is excluded from cover).
Classification of Risk
To simplify a complex subject, we may classify risk
under two broad headings (each having two categories) according to:
(a) its potential financial results; and
(b) its cause and effect.
Financial Results
Risks may be considered as being either Pure or Speculative:
(i) Pure Risks offer the potential of loss only
(no gain), or, at best, no change. Such risks include fire, accident and other
undesirable happenings.
(ii) Speculative Risks offer the potential of gain
or loss. Such risks include gambling, business ventures and entrepreneurial
activities. The majority of the risks which are insured by commercial insurers
are pure risks, and speculative risks are not normally insurable. The reason
for this is that speculative risks are engaged in voluntarily for gain, and, if
they were insured, the insured would have little incentive to strive to achieve
that gain.
Cause and Effect
Risks may also be considered as being either Particular
or Fundamental:
(i) Particular Risks: They have relatively
limited consequences, and affect an individual or a fairly small number of
people. The consequences may be serious, even fatal, for those involved, but
are comparatively localised. Such risks include motor accidents, personal
injuries and the like.
(ii) Fundamental Risks: Their causes are outside
the control of any one individual or even a group of individual, and their
outcome affects large numbers of people. Such risks include famine, war,
terrorist attack, widespread flood and other disasters which are problems for society
or mankind rather than just the ‘particular’ individuals involved.
The majority of the risks which are insured by
commercial insurers are particular risks. Fundamental risks are not normally
insurable because it is considered financially infeasible for insurers to
handle them commercially.
Risk Management
‘Risk management’ is a term which is used with different
meanings:
(a) in the world of banking and other financial services
outside insurance, it is probably used with reference to investment and other speculative
risks.
(b) insurance companies will probably use the term only
in relation to pure risks, but they may well restrict it even further to
insured risks only. Thus, when insurers talk about ‘risk management’,
they could well be referring to ways and means of reducing or improving the insured
loss potential of the ‘risks’ they are insuring, or being invited to
insure;
(c) as a separate field of knowledge and research, risk
management may be said to be that branch of management which seeks to:
(i) identify;
(ii) quantify; and
(iii) deal with risks (whether pure or speculative)
that threaten an organisation. Tools or measures of risk handling include:
- risk avoidance: elimination of the chance of
loss of a certain kind by not exposing oneself to the peril (e.g. abandoning a nuclear
power project so as to eliminate the risk of nuclear
accidents);
- loss prevention: the lowering of the frequency
of identified possible losses (e.g. activities promoting industrial safety);
- loss reduction: the lowering of the severity of
identified possible losses (e.g. automatic sprinkler system);
- risk transfer : making another party bear the
consequences of one’s exposure to loss (e.g. purchase of insurance and contractual
terms shifting responsibility for possible losses);
- risk financing: no matter how effective
the loss control measures an organisation takes, there will remain some risk of
the organisation being adversely affected by future loss occurrences.