Understanding Insurance

7. Gambling vs Insurance: Requirements for insurable risks

We end previous article Between Gambling and Insurance with a statement that basically only pure risks are insurable, while speculative risks are not.

However, it is not necessarily that every pure risks are insurable. In other words, pure risk is not the only condition for a risk to be insurable. To ensure insurance does not turn into gambling, a risk must meet the following requirements in order to be classified as insurable risks:

1. Pure risk

See a brief description on pure risk at the end of the article Between Gambling and Insurance.

2. Fortuitous

The risk to be insured must be accidental and unintentional. The risk owner or other person should not have any power to cause or not cause a risk turn into a loss. It also means the loss that occur must be unpredictable.

3. Large number of homogeneous / similar exposure

To be insurable, we need to have population of the same or similar risks in adequate size. This allows a relatively accurate calculation or prediction of the potential losses incurred on individual or portfolio basis.

4. Non catastrophic

Catastrophic risks cause massive losses, involve large amounts of properties or lives, affecting a very vast area and bring a very large amount of financial loss. Basic problem of catastrophic risk is that it is difficult to model or calculate its potential loss. Since catastrophic risk has very high potential of financial loss, in theory it is not impossible that insurance for catastrophic risk become uneconomical, because the premium to be paid is extremely high, relative to the potential loss.

5. Losses can be stated in terms of time, place and financial size.

This is certainly very important in reducing uncertainty or vagueness or gharar, especially when a loss or claim occurs. With this clarity, claim disputes can be avoided or at least reduced. That is why insurance contract documents must set definitions, terms and conditions clearly and comprehensively.

It should be noted here that in the reality of current insurance practice, these requirements are not all strictly adhered to with full discipline. In certain situation, their relevance may have been weakened. This is in line with the increased knowledge on risks, the availability of more data or information that allows a more in-depth analysis, the development of innovative technology and competitive pressures that encourage insurance companies to expand their offerings. In other words, boundaries of risk insurability is getting expanded over time.

Catastrophic risk is one example where currently insurance for certain catastrophic risks such as floods, earthquakes or wildfires are available in the market, although the risks may not be as fully understood as non-catastrophic risks.

Requirements for the availability of uniform or similar risks in large numbers are also not fully obeyed. Take for example a famous pianist insuring his fingers or a singer / dancer who insures her sexy (sorry) buttocks.

There are also types of insurance that are not fully subject to the requirements of number 5, especially in terms of certainty of financial value. Insurance of paintings of famous painters, for example, where the paintings are insured with very high coverage, far exceeding the price of the canvas, brush and paint. So, so-called sentimental value is very dominant here.

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