To the layman, risk means exposure to danger. The process of managing risk is called Risk management.The importance of Risk management has been recognised and organisations now employ risk managers to specifically manage the risk.

Insurance, as a risk financing tool, provides a convenient way to handle risks.Insurer creates a common pool into which each policy holder pays a fair and equitable premium, according to the risk or loss he brings to the pool.The insurer estimates the cost of probable losses, spreads the losses of few over many, fixes the lost of the premium, receives the premium in the common pool and pays the due claims to those suffering losses.The insurer also undertakes subsidiary services like advice on risk evaluation, loss control, loss prevention etc

While insurance is a tool of risk financing, it has to be understood that insurance does not prevent the risk, nor it can reduce the possibility that a loss will occur. It can only reduce the financial impact in the event of a loss.

Insurance cannot be availed to cover all kinds of risk exposures.

From the standpoint of the Insurer, the insurable risk must need the following criteria :

  1. The risk must involve a loss that is capable of financial measurement. Insurance is applicable only to situations where monetary compensation can be given, following the loss.
  2. There must be some way to determine whether any loss has occurred and how great this loss is. Data should be available, so that the loss can be calculated.
  3. There must be a large number of similar, homogenous risks to be covered. Historical data should be available, so that the probability of loss can be predicted. Only then can a reasonably close calculation of the probability of frequency and severity of the loss be made, and fair and economically feasible premium be charged.
  4. The possible loss must be accidental and random in nature, beyond the control of the Insured. There is risk only when there is uncertainty of the event.
  5. The person insuring must be the one who stands to suffer from financial loss (difficult to bear) when the risk occurs. The loss must be severe enough to cause financial hardship.
  6. The peril should not be catastrophic in nature and should be unlikely to affect all the insured persons simultaneously. If a loss were to occur to a large number of insured persons at the same time, the claims may exceed expectations. In such a case, the insurer would not be likely to have adequate resources.

 


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