Insurable risk Definition
An insurable risk is a risk that meets the ideal criteria for efficient insurance. The concept of insurable risk underlies nearly all insurance decisions.
For a risk to be insurable, several things need to be true:
- The insurer must be able to charge a premium high enough to cover not only claims expenses, but also to cover the insurer's expenses. In other words, the risk cannot be catastophic, or so large that no insurer could hope to pay for the loss.
- The nature of the loss must be definite and financially measurable. That is, there should not be room for argument as to whether or not payment is due, nor as to what amount the payment should be.
- The loss should be random in nature, else the insured may engage in adverse selection (antiselection).
Insurance is not effective for risks that are not insurable risks. For example, risks that are too large cannot be insured, or the premiums would be so high as to make purchasing the insurance infeasible. Also, risks that are not measurable, if insured, will be difficult if not impossible for the insurer to quantify, and thus they cannot charge the correct premium. They will need to charge a conservatively high premium in order to mitigate the risk of paying too large a claim. The premium will thus be higher than ideal, and inneficient.