Pure Risk vs. Speculative Risk
Insurance companies normally only indemnify against pure risks, otherwise known as event risks. A pure risk includes any uncertain situation where the opportunity for loss is present and the opportunity for financial gain is absent.
Speculative risks are those that might produce a profit or loss, namely business ventures or gambling transactions. Speculative risks lack the core elements of insurability and are almost never insured.Key Takeaways
- Speculative risks are almost never insured by insurance companies, unlike pure risks.
- Insurance companies require policyholders to submit proof of loss (often via bills) before they will agree to pay for damages.
- Losses that occur more frequently or have a higher required benefit normally have a higher premium.
Due to Chance
An insurable risk must have the prospect of accidental loss, meaning that the loss must be the result of an unintended action and must be unexpected in its exact timing and impact.The insurance industry normally refers to this as "due to chance." Insurers only pay out claims for loss events brought about through accidental means, though this definition may vary from state to state. It protects against intentional acts of loss, such as a landlord burning down his or her own building.
Definiteness and Measurability
For a loss to be covered, the policyholder must be able to demonstrate a definite proof of loss, normally in the form of bills in a measurable amount. If the extent of the loss cannot be calculated or cannot be fully identified, then it is not insured. Without this information, an insurance company can neither produce a reasonable benefit amount or premium cost.Statistically Predictable
Insurance is a game of statistics, and insurance providers must be able to estimate how often a loss might occur and the severity of the loss. Life and health insurance providers, for example, rely on actuarial science and mortality and morbidity tables to project losses across populations.
Not Catastrophic
Standard insurance does not guard against catastrophic perils. It might be surprising to see an exclusion against catastrophes listed among the core elements of an insurable risk, but it makes sense given the insurance industry's definition of catastrophic, often abbreviated as "cat." There are two kinds of catastrophic risk. The first is present whenever all or many units within a risk group, such as the policyholders in that class of insurance, are all be exposed to the same event. Examples of this kind of catastrophic risk include nuclear fallout, hurricanes, or earthquakes. The second kind of catastrophic risk involves any unpredictably large loss of value not anticipated by either the insurer or the policyholder. Perhaps the most infamous example of this kind of catastrophic event occurred during the terrorist attacks on Sept. 11, 2001.Some insurance companies specialize in catastrophic insurance, and many insurance companies enter into reinsurance agreements to guard against catastrophic events. Investors can even purchase risk-linked securities, called "cat bonds," which raise money for catastrophic risk transfers.