Insurance is to cover the financial risk but what type of risk can be insured? Can risk in gambling be insured or a startup business or a stock investment? No because risk in such endeavours is with the intention to make gains. What if the gain is not made, should the insurance company reimburse in such a case? No, hence such risks cannot be insured. These are known as speculative risks in insurance terminology. What about risks that can be covered? Like a vehicle can be insurance, a person’s life can be insured and a building can be insured – and here the intention is to reduce the loss not to let the insurer make gains. If the property is damaged there is a coverage limit to restrict the amount that can be claimed. Hence insurance is not for gains but to reduce losses. Such a risk can be covered and is called as Absolute Risk or Pure Risk. In speculative risk there are 3 possibilities – Gain, Nothing Happens or Loss. In Pure risk there are only 2 possibilities – Nothing Happens or Loss.
Risk can be avoided, reduced, retained or transferred. For example To not to drive the car to keep it safe from accidents is an example of avoiding risk. To drive only very early morning or late evening in low traffic is an attempt to reduce risk of accident. To drive an uninsured car (which is illegal by the way) is to retain the risk with self. More examples of retaining risk are having no health insurance or to keep the premium for an insurance policy very low but with high deductible. To buy an insurance policy for the car and let the insurance company be responsible for claims arising out of car accident is an example of transferring the risk to the insurance company.