Fundamentals of Risk and Insurance
Insurance is something that takes the financial risk of some catastrophic event -- such as death, illness or destruction of property -- and spreads that risk over a large number of people. In insurance terms, risk is the probability of incurring a certain amount of financial damage from such a catastrophic event.
Other People Are Reading
-
Insurance Companies
-
Insurance companies raise money in three ways: policy sales, stock sales and investment returns. The two main types of insurance companies are stock companies, which deal with all types of policies, and mutual companies, which deal primarily with life and casualty policies. Stock companies begin with an IPO, which is an event in which the company raises money by selling corporate stock. They then sell insurance policies to clients with the understanding that they will pay certain amounts of money to clients if certain catastrophic events occur, using funds collected to make investments into such things as stocks, bonds and real estate. Mutual companies operate in a similar fashion except that they have no stockholders: All benefits from company investments go toward benefits for the policyholders.
Types of Risk
-
Speculative risk is a risk in which profit and loss are both possible. For instance, if you buy a stock or place a bet, you stand the chance of both directly losing and directly gaining money, dependent upon forces beyond your control. No insurance covers speculative risk.
The type of risk for which insurance companies do provide coverage is called static risk. Such risks are premature death, illness, unemployment, loss of property and financial liability. Financial liability can be anything for which someone can claim loss and file a civil suit against you.
-
Risk vs. Peril
-
Some confusion exists between what insurance companies mean when they say "risk" and what they mean when they say "peril." While a risk is a particular type of loss that you may be in danger of experiencing, a peril is the means by which that loss occurs. For instance, homeowner's insurance may provide financial protection from damages to your home, but the policy will stipulate the specific types of events that must cause that damage in order for you to collect. Some common types of peril listed in homeowner's insurance policies are lightning, fire, flood, vandalism, theft and explosion.
Calculating Risk
-
Insurance companies employ actuaries to calculate the levels of risk for various sectors of the population, and their premiums reflect these calculations. For instance, auto insurance tends to be more expensive for 19-year-old men than for 40-year-old women because 19-year-old men have more of a tendency to have automobile accidents. In contrast, cancer insurance tends to be more expensive for 40-year-old women than for 19-year-old men because they have more of a tendency to contract cancer. Depending on the policy, insurance companies may categorize people according to medical history, age, sex, driving history, occupation and place of residence. In order to remain competitive by offering the lowest premium requirements possible, insurance companies offer lower prices to people who fall into lower risk sectors.
-
