MEANING AND TYPES OF RISK AND HAZARD IN INSURANCE

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Risk is the condition of being exposed to adversity. 

It is a circumstance in which there is a possibility of adverse deviation from the desired outcome.

Types of Risks

Risk can be classified in many ways. However, for our purpose, we shall classify risk into four: 

1. Financial vs Non-financial risks: An important distinction is between financial and non-financial risks.

Financial risks involve those risks whose outcomes can be measured in monetary terms. For example, material damage to a building after a fire outbreak.

Non-financial risks involve those risks whose outcomes cannot be quantified in monetary terms. For example, Emotional trauma.

2. Pure and speculative risks: The distinction between pure and speculative risks is critical.

A pure risk involves those situations in which there is a possibility of loss or no loss. 

In other words, Pure risk involves loss or break-even situations. There is no gain attached to the situation

When a person buys a house, for example, he or she assumes the risk that something will happen to the house and cause it to be destroyed. The possible outcome here could be either a loss or no loss.

As another example, a person who buys an automobile assumes the risk that the car will have an accident or will not have an accident.

Pure risk vs speculative risk

Speculative risk, on the other hand, involves loss, break-even or gain situations. 

In other words, speculative risk refers to a situation in which a loss, no loss, or gain is possible.

The most common speculative risk is Gambling. All gamblers know that there are faced with three outcomes: Lose money (possibility of loss), No loss or gain (possibility of break-even) and win money (possibility of gain).

It is intuitive to note that speculative risks are not insurable because they are willingly undertaken in hope of making profit.

3. Fundamental and particular risks: Another important classification of risks is between fundamental and particular risks

Fundamental risks are those losses that are impersonal in origin and consequence. Human beings cannot influence them.

They include earthquakes, floods, landslides, and hurricane.

Particular risks, in contrast, are those losses that arise out of individual events. They are personal and their consequences are felt by a single individual.

4. Static and dynamic risks: The distinction between static and dynamic risk is based on its origin.

Static risks are those risks that remain constant even if the economy does not change. They are usually the product of human error or dishonesty.

Static risks tend to occur with a degree of regularity over time. They're often predictable, which makes them easy to insure.

By Contrast, Dynamic risks are risks that occur as a result of changes in the economy

Changes in the price level, consumer tastes, income and output can all lead to dynamic risk.

Dynamic risks, unlike static risks, are unpredictable and, as a result, are not insurable.

Hazard

Hazard is a condition that increases the likelihood of a loss. It can also be defined as the condition affecting peril.

Hazard may relate to the physical condition that increases the effect of peril. Examples are faulty cars, poor construction design.

Hazard may also relate to the moral condition that increases the effect of peril. Examples are exaggerated loss, dishonest behaviour.

Types Of Hazard

1. Physical Hazards: These are those physical conditions that increase the likelihood of loss from various peril. They are mostly physical.

An example of a physical hazard is faulty wiring, which can increase the probability of a fire occurring. 

Other examples of physical hazards are  wrong location of a house, poor building materials and faulty cars.

2. Moral hazards: These are those dishonest tendencies of the insured that can increase the probability of loss. They have to do with the integrity of the insured person.

Examples are frauds, inflating insurance claims etc.

3. Morale hazards: These result insured person's careless attitudes toward loss, which may increase the likelihood or severity of a loss.

When a person is covered by insurance, for example, they may be more careless about preventing losses.

4. Legal Hazards: These refer to the increase in the probability of loss as a result of  the legal doctrines adopted by the legislature and created by the court of law of a country.

For example, a court order directing an insurance company to pay an insurance claim that would have otherwise not been paid.

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