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Classification Of Risk
In this section, we will study the different classifications of risk.
What is Financial Risk and Pure Risk?
Financial risks are those whose outcome can be measured in monetary terms.
Example – death of family’s income provider, loss of earnings due to disease, retirement
Pure risks are those risks where there is no possibility of making a profit. In pure risks there can be a loss and the best possible outcome is one of breaking even.
With a pure risk the possibility of any benefit occurring as a result of the insured event taking place is nil. This type of risk is associated with those events which are totally out of the control of an individual.
Particular risks are personal or local in their effect. The consequences of these risks occurring affect specific individuals or local communities.
(Source : IRDAI study material for IC-33 exam)
What is Subjective Risk and Acceptable Risk?
The risk perceived by a person based on his mental condition or state of mind is called Subjective Risk. Two persons in the same situation can have a different perception of risk
Regarding uncertainty of an event.
The level of subjective risk which an individual feels comfortable in facing and the size of loss that could be absorbed is called Acceptable Risk. Financial considerations always influence acceptable risk.
What is Risk Management & Risk Analysis?
Risk management is concerned mainly with pure risk and managing them. The process of risk identification and evaluation or measurement is called Risk Analysis.
Risk identification means that until and unless a risk is identified as a threat, it cannot be managed. Risk measurement and or evaluation is necessary to choose the appropriate method or tool of dealing with the risk.
What is Underwriting?
Underwriting is the name given to the procedure of:
- assessing the risk which people bring to the pool;
- deciding whether or not to accept the risk, or how much to accept;
- determining the terms, conditions and scope of the cover to be offered; and
- calculating a suitable premium.
For life insurance, underwriters are responsible for selecting those individuals the insurance company can insure out of those submitting proposals, and also the premium at which it can insure them, based on their risk profile.
As you have seen, the business of insurance is based on the principle of risk sharing. The insurance company carries the risks of the person insured in accordance with the policy terms and conditions. Hence, the underwriters have to be extra careful in choosing the individuals to be insured from the group of proposers and in setting a fair price in line with the risk that each individual presents to the pool. An underwriter who fails to do this can affect the stability of an insurance company’s business.
(Source : IRDAI study material for IC-33 exam)
