Insurance is a contract between two parties – the insurer and the insured. The insurer undertakes to pay a certain amount to the insured up on the happening of a certain loss causing event. In exchange for this undertaking, the insured regularly pays an amount called premium to the insurer.
A person or a business buys insurance as protection against risk. A person who wants to take insurance may want to pass on many kinds of risks to the insurer. But for a risk to be insurable, it has to meet certain criteria. First of all, one needs to know what is insurable risk.
They should be a large number of people who have or are willing to take insurance for a particular risk. If it is just a few people buying insurance, then the insurer will suffer from the problem of ‘adverse selection’. This means that only people who are most likely to face the risk will insure themselves and the insurance company will end up paying large amounts as claims settlement resulting in losses or reduction in profits.
For a risk to be insurable, the extent and amount of loss has to definite. The insurer will refuse to issue a policy for a risk where the loss is vague and not measurable. One should be able to clearly say that a loss of a particular amount has indeed taken place.
Another answer to the question “what is insurable risk?” is that the loss suffered should be due to a contingent event. In other words, there should be chances of that event occurring or not occurring. If a particular event is it sure to happen and is not fortuitous, then the risk cannot be insurable.
These basic conditions are kept in mind by the insurer before agreeing to assume a particular risk of the insured. The insurer is in the business of insurance for the purpose of making profit. If he does not follow the tenets of “What is insurable risk?”, he would end up paying large amounts of money for claims settlement.
It would be advisable for a person who wants to buy insurance, to first understand “What is insurable risk?” If the risk is indeed insurable, he can then approach the insurer and buy the relevant insurance policy.