Types of Risks

With regards insurability, there are basically two categories of risks;

speculative or dynamic risk; and
pure or static risk

Speculative or Dynamic Risk

Speculative (dynamic) risk is a situation in which either profit OR loss is possible.  Examples of speculative risks are betting on a horse race,
investing in stocks/bonds and real estate.  In the business level, in the
daily conduct of its affairs, every business establishment faces
decisions that entail an element of risk.  The decision to venture into a
new market, purchase new equipments, diversify on the existing product
line, expand or contract areas of operations, commit more to advertising,
borrow additional capital, etc., carry risks inherent to the business.  The
outcome of such speculative risk is either beneficial (profitable) or loss.  
Speculative risk is uninsurable.

Pure or Static Risk

The second category of risk is known as pure or static risk.  Pure (static)
risk is a situation in which there are only the possibilities of loss or no
loss, as oppose to loss or profit with speculative risk.  The only outcome
of pure risks are adverse (in a loss) or neutral (with no loss), never
beneficial.  Examples of pure risks include premature death, occupational
disability, catastrophic medical expenses, and damage to property due to
fire, lightning, or flood.

It is important to distinguish between pure and speculative risks for three
reasons.  First, through the use of
commercial, personal, and liability
insurance policies, insurance companies in the private sector generally
insure only pure risks.  Speculative risks are not considered insurable,
with some exceptions.  

Second, the law of large numbers can be applied more easily to pure
risks than to speculative risks.  The law of large numbers is important in
insurance because it enables insurers to predict loss figures in
advance.  It is generally more difficult to apply the law of large numbers
to speculative risks in order to predict future losses.  One of the
exceptions is the speculative risk of gambling, where casinos can apply
the law of large numbers in a very efficient manner.

Finally, society as a whole may benefit from a speculative risk even
though a loss occurs, but it is harmed if a pure risk is present and a loss
occurs.  For instance, a computer manufacturer's competitor develops a
new technology to produce faster computer processors more cheaply.  
As a result, it forces the computer manufacturer into bankruptcy.  
Despite the bankruptcy, society as a whole benefits since the
competitor's computers work faster and are sold at a lower price.  On
the other hand, society would not benefit when most pure risks, such as
an earthquake, occur.

Types of Pure (Static) Risk

The major types of pure risk that are associated with great economic and
financial insecurity include;

personal risks;
property risks; and
liability risks.

Personal risks are risks that directly affect an individual.  They involve the possibility of loss or reduction of income, of extra
expenses, and the elimination of financial assets.  
There are four major personal risks;

premature death
old age
poor health

Premature death risk is defined as the risk of the death of the head of a household with unfulfilled financial obligations.  These
can include dependents to support, a mortgage to be
paid off, or children to educate.

Old age is a risk of insufficient income during retirement.  When older
workers retire, they lose their normal amount of earnings.  Unless they
have accumulated sufficient assets from which to draw on, they would
be facing a serious problem of economic insecurity.

Risk of
poor health includes both catastrophic medical bills and the loss
of earned income.  The cost of health care have increased substantially
in recent years.  The loss of income is another major cause of financial
instability.  In cases of severe long term disability, their is a substantial
loss of earned income, medical bills are incurred, employee benefits may
be lost, and savings depleted.

The risk of
unemployment is another major threat to most families.  
Unemployment can be the result of a industry cycle downswing,
economic changes, seasonal factors and frictions in the labor market.  
Regardless of the cause, unemployment can create financial havoc in
the average families by way of loss of income and employment benefits.

Property risk is the risk of having property damaged or loss from
numerous perils.  Property  loss can occur as a result of fire, lightning,
windstorms, hail, and a number of other causes.

Liability risks are another important type of pure risk that many people
face.  More than ever, we are living in a litigious society.  One can be
sued for any frivolous reason.  One has to defend himself when sued,
even when the suit is without merit.  

Fundamental Risks and Particular Risks  

Fundamental risks affect the entire economy or large numbers of people
or groups within the economy.  Examples of fundamental risks are high
inflation, unemployment, war, and natural disasters such as
earthquakes, hurricanes, tornadoes, and floods.

Particular risks are risks that affect only individuals and not the entire
community.  Examples of particular risks are burglary, theft, auto
accident, dwelling fires.  With particular risks, only individuals experience
losses, and the rest of the community are left unaffected.

The distinction between a fundamental and a particular risk is important,
since government assistance may be necessary in order to insure
fundamental risk.  Social insurance, government insurance programs,
and government guarantees and subsidies are used to meet certain
fundamental risks in our country.  For example, the risk of unemployment
is generally not insurable by private insurance companies but can be
insured publicly by federal or state agencies.   In addition, flood
insurance is only available through and/or subsidized by the federal
MY Insurance Agency
The materials on this page is meant to be
informative in nature.  Due to the ever
changing and varying state laws, and the fact
some insurers offer coverage in slightly
different forms from the Insurance Services
Office (ISO) standard forms, we cannot
guarantee the accuracy of the materials on
this page.