Risks & Insurance

Risk in insurance has several meanings, but the core idea is uncertainty about the outcome of a future event — specifically the possibility of an unfavourable deviation from what is expected, usually a financial loss. It is important to keep three related terms distinct because the exam tests them constantly.

A peril is the cause of a loss — the event that actually produces the damage. Fire, flood, theft, storm, collision, illness and death are all perils.

A hazard is a condition or circumstance that increases the likelihood or severity of a loss arising from a peril. Hazards do not cause loss by themselves; they influence how probable a peril is or how bad the outcome will be.

Hazards fall into three types. A physical hazard is a tangible, measurable condition of the subject matter (e.g. storing petrol next to a building, worn car brakes, faulty wiring). A moral hazard relates to the dishonesty or bad character of the insured — the deliberate intent to cause or exaggerate a loss (arson for profit, inflated claims, fraud). A morale hazard (sometimes called attitudinal hazard) is carelessness or indifference that arises simply because a person has insurance — leaving doors unlocked, not bothering to prevent loss — without any dishonest intent.

Risks are classified in ways that decide whether they can be insured. The single most tested distinction is pure vs speculative risk.

A pure risk offers only two possible outcomes: a loss or no loss — there is no possibility of gain. Examples: your house may burn down or it may not; you may fall ill or you may not. Only pure risks are generally insurable.

A speculative risk carries three possible outcomes — loss, no change, or gain. It is entered into voluntarily in the hope of profit. Examples: gambling, share trading, starting a business, betting. Speculative risks are generally uninsurable because the prospect of gain removes the pure-loss character insurers require.

The second classification is fundamental vs particular. A fundamental risk is impersonal in origin and effect — it arises from causes beyond any individual's control and affects large numbers of people or society as a whole (earthquakes, war, famine, pandemics, widespread unemployment). A is personal or localised in both cause and effect, affecting individuals rather than the community (a house fire, a car accident, a burst pipe). Particular risks are generally insurable; many fundamental risks are not, and are often handled by government or pools.