1.4.4 Elements of Insurable Risk
One of the criteria for an insurable risk is that it NOT be catastrophic. A principle of insurance holds that only a small portion of a given group will experience loss at any one time. Risks that would adversely affect large numbers of people or large amounts of property - wars or floods, for example - are typically not insurable.
In order for a pure risk to be insurable, it must meet the following criteria.
- Loss Must Be Due To Chance - Any loss must be a mishap or of an accidental nature.
- Loss Must Be Definite And Measurable - The insurer must be able to explicitly identify the loss and be able to calculate the extent of loss.
- Risk Must Be Predictable - Risk must be determinable through statistical data and expressed as a percentage of a fraction.
- Loss Must NOT Be Catastrophic - The insurer's cost of disastrous events such as floods, earthquakes, and hurricanes must be within the insurer's ability to pay claims costs.
- Exposure To Loss Must Be Large - Utilization of the law of large numbers.
- Loss Exposures Must Be Randomly Selected - Using methodical techniques and systematic approaches could lead to adverse selection.*
*Adverse selection refers to the tendency for those individuals who present less favorable insurance risks (i.e., people in poor health) to seek or continue insurance to a greater extent than other risks. The systematic selection of loss exposures is prohibited due to the rules of adverse selection.
To be insurable, a risk must involve the chance of loss that is unexpected and outside the insured's control.
Can you give me an example of adverse selection?
