Insurance law is the name given to practices of law surrounding insurance, including insurance policies and claims. Insurance regulation that governs the business of insurance is typically aimed at assuring the solvency of insurance companies. Thus, this type of regulation governs capitalization, reserve policies, rates, and various other "back office" processes.
All assets have some economic value attached to them. There is also a possibility that these assets may get damaged/destroyed or become non-operational due to risks like breakdowns, fire, floods, earthquakes, etc. Different assets are exposed to different types of risks like a car has a risk of theft or meeting an accident, a house is exposed to the risk of catching fire, a human is exposed to the risk of death/accident. Hence the insurance is required to cover all those risks. The author will endeavor to explain this concept of risk.
Risk in insurance is a measurable uncertainty. The uncertainty is the “unfortunate event”, and when that event happens, there is a loss(financial). The objective of insurance is to cover the loss. Insurance does not eliminate the risk, but, when covered, it reduces the financial loss resulting from the happening of an uncertain event. In Life, Marine, Fire, & other insurances, the risk covered by the policy, provides protection against ‘loss’. This is pre-estimated &calculated at the time of taking out the policy. Hence, the uncertainty is measured in terms of money and the policy fixes it as “insured amount”.
CLASSIFICATION OF RISK
The risk can be classified in the following categories:
1. Objective and Subjective Risk
A. Objective risk
Objective risk is the actual losses for a sample in a given period, which can alter significantly from expected losses, and is inversely proportional to the square root of the sample size — the law of large numbers. Suppose a coin is flipped 10 times, it is assumed that 5 of those flips will bear heads and the other 5 will bear tails. However, in maximum sets of 10 flips, the actual number of heads and tails will vary from this assumption, and it may differ significantly. for instance, all may be heads. However, as the number of flips is increased, the number of heads and tails directs toward equality. In 1,000,000 flips, it is unpropitious that they will all be heads or all tails, and the number of both will be closer to the mean. Because objective risk is the actual number of losses in a given period for a given sample, it may vary significantly between different samples, even if those samples have the same predicted losses. Statistically, the objective risk is commensurate with the variance, and hence, the standard deviation, of the sample.
B. Subjective risk
Subjective risk is described as uncertainty based on a person’s mental condition or state of mind. For example, an individual is drinking in a bar and attempts to drive home. The driver may be uncertain whether he or she will reach home safely without being arrested by the police concerning drunk driving. This mental uncertainty is named subjective risk. Often the subjective risk is manifested in terms of the degree of belief. The consequence of subjective risk deviates depending on the individual. As two persons in identical circumstances may have a different perception of risk, and their conduct may be altered accordingly.
2. Financial and non-financial risk
A. Financial Risk:
Financial Risk indicates the danger in which the outcome of an event is measurable in terms of the money, i.e., any loss that could transpire due to the risk can be measured by the concerned person in a monetary value. An example of the financial risk: a loss to the goods in the warehouse of the company due to the fire. These risks are insurable and are usually the main subjects of the insurance.
B. Non-Financial Risk:
Non-Financial risk pertains to the risk in which the result of the event is not measurable in terms of the money, i.e., any loss that could occur due to the risk cannot be measured by the concerned person in the monetary value. An example of the non-financial risk: the risk of a poor assortment of the brand while buying mobile phones. These risks are uninsurable as they cannot be measured.
3. Pure and Speculative Risks
A. Pure Risk:
Pure risk refers to the situation where it is certain that the outcome will lead to only loss of the concerned person or it could only head to the condition of the break-even to the person, but it can never cause profit to the person. An example of pure risk: the feasibility of damage to the house due to natural calamity.
In case any natural calamity transpires, two situations can appear, first is that it will ruin the house of the person including household items, or the second is that it will not affect the person’s home and household items. the first situation will lead to a loss to the person whereas the second situation will not yield any profit or gain to the person i.e., the position of break-even. however, it cannot yield any sort of profit to the concerned person. Hence, this will fall under the pure risk. Besides, these risks are insurable. The major types of pure risks that are associated with great financial and economic insecurity include personal risks, property risks, and liability risks.
Personal risk is particularly concerned with death and the time of its occurrence. And apart from death, there is incapacity through accident, injury, illness, or old age – loss of earning power.
Property risk pertains to losses connected with the ownership of a property such as destruction of property by fire, lightning, windstorm, flood, and other forces of nature. Property risk leads to direct loss and consequential loss. For example, when the New York twin towers were destroyed, the direct loss was the building itself and the consequential loss was the benefit generated from it including the rent income. Further, these property losses can be classified as either direct loss or indirect loss.
B. Speculative Risk
Speculative risk refers to the situation where the effect of the outcome is not specific, i.e., it could lead to the condition of loss or of profit, or of break-even. Moreover, these risks are usually not insurable. Suppose a person purchasing the shares of a company. Further, when these sales shares would be sold, the prices of these shares can go in any direction, and a person can induce a loss, or a profit, or no loss, no profit. Hence, this situation will fall under the category of Speculative risk.
People are more averse to pure risks as compared to speculative risks as in a speculative risk situation, people deliberately create the risk when they apprehend that the favorable outcome is, indeed, so promising.
4. Static and Dynamic Risks
A. Dynamic risk
Dynamic risk arises from the various changes that occurred in the economy. Some of these changes are price level changes, changes in consumer taster, income distribution, technological changes, political changes, and the like. Further, these are less predictable and hence beyond the control of risk managers.
B. Static risk
On the other hand, Static risks refer to those losses that can occur without any changes in the overall economy. Moreover, they are the losses stemming from causes than the changes in the economy. Unlike dynamic risks, they are predictable and could be controlled to some extent by exercising loss prevention measures. Many of the perils stumble under this category.
4.Fundamental and Particular Risks
The final classification correlates to both the cause and effect of risk.
A. Particular Risk
Particular risk refers to the risk which chiefly arises because of the actions or the interventions of the individual or the group of some individuals. So, the origin of the particular risk by individual level and impact of the same is felt at a localized level. An example of a specific chance includes an accident on the bus. Generally, these risks are the main subjects of the insurance. Further, these risks are insurable.
B. Fundamental Risk
Fundamental risk refers to the risk which transpires due to the causes which are not under the control of any person. Therefore, it can be said that the fundamental risk is impersonal in its origin and its consequences. The impact of these risks is primarily suffered by a group, i.e., it affects the large population. The fundamental risk includes risks on the group by the occurrence of events like natural calamity, economic slowdown, etc. Further, these risks are also insurable.
Next is Risk management. Risk management ensures that an organization identifies and understands the risks to which it is exposed. Risk management also guarantees that the organization creates and implements an effective plan to prevent losses or reduce the impact if a loss occurs. A risk management plan includes strategies and techniques for recognizing and confronting these threats. Good risk management doesn’t have to be expensive or time-consuming; it may be uncomplicated as answering these three questions:
1. What can go wrong?
2. What will we do, both to prevent the harm from occurring and in response to the harm or loss?
3. If something happens, how will we pay for it?
Further, the Risk Management Process includes five steps. These are as follows:
Thus, the risk insurance or the risks in the insurance are the speculations that unexpected events will occur, which could further induce the loss to the person or his property. However, nowadays most of the risks are insurable by the insurance companies. Proper risk management schemes can be initiated to lower these risks. The companies try to lower the impact of these risks firstly by calculating the probability of the events and their impact and then calculate the premium accordingly.
1. Murthy: Modern Law of Insurance in India