Risk (insurance)
Also known as: insurance risk
In insurance, risk is the chance or uncertainty of loss. Insurers distinguish pure risk — where only loss or no loss is possible — from speculative risk, and only pure risk is insurable.
For insurance purposes, risk is defined as the uncertainty or chance of loss. The uncertainty is the essential part: if a loss is certain to occur, there is nothing to insure against, and if it cannot occur at all, no coverage is needed. Insurers separate pure risk, which offers only the possibility of loss or no loss (a house burning down), from speculative risk, which also offers the possibility of gain (buying a stock). Only pure risk is insurable.
Two related terms are routinely tested with risk. A peril is the actual cause of loss — fire, theft, windstorm, illness. A hazard is a condition that increases the likelihood or severity of a loss. Physical hazards are tangible conditions like an icy sidewalk; moral hazards involve dishonest tendencies, such as an applicant who might stage a loss; and morale hazards involve carelessness born of having coverage, like leaving a car unlocked.
There are five standard methods of handling risk, commonly remembered by the acronym STARR: sharing risk among a group, transferring it to another party, avoiding the activity that creates it, reducing the chance or severity of loss, and retaining it yourself through a deductible or self-insurance. Insurance is the transfer method — the insured pays a premium and the insurer assumes the financial consequence of a covered loss, spreading it across a large pool of similar exposures so the law of large numbers makes losses predictable.
Every state life, health, and property and casualty licensing exam opens with these general insurance concepts, and they are among the most reliably tested items on the exam. Be ready to define risk as the chance of loss, distinguish peril from hazard, identify the three hazard types, and list the methods of handling risk.
Key takeaways
- Risk in insurance is the chance or uncertainty of loss.
- Only pure risk — loss or no loss — is insurable; speculative risk, which includes the chance of gain, is not.
- A peril is the cause of loss, while a hazard is a condition that increases the chance or severity of loss.
- Physical, moral, and morale hazards are the three hazard categories tested on licensing exams.
- The five methods of handling risk are sharing, transferring, avoiding, reducing, and retaining.