Characteristics of an Insurable Risk

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Defining an Insurable Risk 

In regards to insurance, it is important to understand that not everything is insurable. In order for a risk to be insurable, it must have these key characteristics.

Fair Premiums 

This means that the insurer must be able to cover claims and expenses with premium income and thus if premiums must be set too high then the risk is not insurable. An example of this would be how California homeowners policies exclude earthquake losses because the disasters happen so frequently, instead, carriers offer stand-alone earthquake policies that result in a higher premium but they cover the insured in the event of an earthquake.

Risk Must Be Definable

Another characteristic of insurable risks is that the risk must be definable. This means that the insurer can define the exact conditions under which the item is covered by the policy. The item that is being covered must also have a precise value and must be definable meaning a house, car, diamond ring, etc.

Losses Must Be Unexpected

In order for a risk to be insurable, losses must be random and unexpected. This means that the losses are unforeseeable, reasonably unpreventable and are overall completely random in nature. A prime example of a loss that isn’t insurable is flooding as flooding has become expected depending on the area you live in.

Losses Must Be Substantial 

Another qualification for a risk to be insurable is the loss must cause a substantial economic hardship. This is why every policy has a deductible so that losses that are not costly do not have to be paid by the insurer.

Policy Must Have Exclusions 

The insurer must exclude coverage for large scale and catastrophic events such as war and terrorism, nuclear and missile attacks, earthquakes, flood, wind events, etc.

Must Comply With the Law of Large Numbers

The last key quality of an insurable risk is that it must comply with the law of large numbers. This means that the insured must insure a large number of similar risks. This helps spread risk across more policies and helps the insurer predict losses more accurately. An example is homes, cars, lives, etc. This is why an auto insurer cannot insure a spaceship because they would only insure one spaceship thus not enough similar risks.