The big deal about insurable risks is that it represents the only category of risk that insurers would ensure. Some risks might be insurable, but not feasible to ensure. However, one would never see an insurer providing coverage for a risk that does not meet the criteria associated with insurability. Since insurers are in the sector for profit, they simply cannot afford to eschew selectivity when it comes to what they would accept on their portfolio. Once an insurer deems a risk insurable, the next consideration would be the level of insurability, which would determine how much the premium is. Eight fundamental properties of risks are used to determine risk insurability.
With any form of insurance, there should be a reasonable degree of uncertainty about the timing of loss/damage or injury. It must not be expected at a certain time. Even with life insurance, the principle of uncertainty applies to an extent. While we know that everyone must die at some point, there must be reasonable uncertainty about the timing of death. If a loss is expected, forecasted, or anticipated, the risk would not likely be deemed insurable.
From the policy owner’s point of view, the chance of any risk occurring at a particular place and time must be the subject of chance. This differs from uncertainty, since uncertainty assesses the risk itself. The capricious nature of an insurable risk implies that the policy owner cannot intentionally cause the loss – directly or indirectly. Insurers typically provide exclusions for risk cover that is indirectly (negligence) or directly (fraud) caused by the policy owner.
• Determinable risk
Insurance actuaries should be able to apply statistical methods and techniques in determining the probability of the risk occurring. With different types of insurance, the factors used in determining probability of the loss vary.
• Sufficiently large market for that risk
As with any business, insurers need to have a market to which they can sell. Insurance is big business, so there are large markets for it. However, if an insurer wants to insure an uncommon risk, it should be spread over a large pool of persons to make it viable and profitable. If this were not the case, the likelihood of incurring an underwriting loss increases drastically.
• Reasonable cost
Insurance cost is related to the market size as well as the nature of the risk. Insurance is about pooling premiums so that those affected by loss or damage can be compensated from the pool of funds. If premiums for a risk were too high, then it would be prohibitive to offer coverage. Persons or entities must be able to afford the premiums for the risk covered.
Insurance was not designed to cover expenses that people could easily cover for themselves. Insurance is really for losses that represent a major setback to the insured. If a loss is not significant (like losing a cheap cell phone), the risk of loss is simply not worth covering.
• The risk must not be financially catastrophic
While loss must be significant, it must not be catastrophic. Ironically, catastrophic losses might need insurance the most. However, such losses can render insurance providers insolvent – hence they avoid them. Insurers cover substantial risks still, but they spread the risk through reinsurance. Reinsurance actually allows several otherwise catastrophic risks to become insurable; it does this by decreasing the threshold for catastrophic losses for one particular insurer.
• Before insuring a risk, the insurer should be able to answer two basic questions:
When am I required to pay policy benefits?
How much am I required to pay?
After examining these characteristics of insurable risks, it is easier to understand why insurers do not accept certain risks, and why they might deny or rate particular applications. Applying all elements of insurability ultimately protects the insurer and the insured.