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Insurance Laws and Practices

Notes 16. If the costs are not too high, you can assume some risks by assuming the potential for
………………………………. costs.

2.6 Requirements of an Insurable Risk

You need to know that insurers normally insure only pure risks. However, all pure risks are
also not insurable. Certain requirements usually must be satisfied before a pure risk can be
insured. There are six requirements of an insurable risk.

1. Large Number of Exposure Units: The first and foremost requirement of an insurable risk
is presence of large number of exposure units to be given insurance protection. Ideally,
there should be a large group of nearly similar exposure units that are subject to the same
peril or group of perils.

Example: A large number of houses in a city can be grouped together for purposes of
providing property insurance.

The purpose of this, first requirement is to enable the insurer, i.e., the insurance company
to predict loss based on the law of large numbers. Loss data can be compiled over a period
of time, and losses for the group as a whole can be predicted and estimated. The loss costs
can then be spread over all insured individuals. This is how premium is determined.

2. Accidental and Unintentional Loss: The second requirement is that the loss should be
accidental and unintentional. Ideally the loss should be by chance and outside the insured’s
control. Thus, if a person intentionally causes a loss, he or she should not be indemnified
for the loss.
The above condition is necessary due to two reasons:
(a) If intentional losses are paid, moral hazard would be substantially increased, and
premiums would rise as a result. This would result in substantial increase in premiums
and fewer persons will purchase the insurance. Thus, insurer might not have a
sufficient number of exposure units to forecast future losses.
(b) The loss should be accidental because the law of large numbers is based on the
random happening of events. A deliberately caused loss is not a chance event, as the
insured knows when the loss will take place. Thus, forecast of future occurrences
may be very inaccurate if a large number of intentional or non-random losses occur.
3. Determinable and Measurable (Calculable) Loss: The loss should be both determinable
and calculable. This means the loss should be definite as to cause, time, place, and amount.
But some losses are difficult to determine and measure. For example, under a disability-
income policy, the insurer promises to pay a monthly benefit to the disabled person if the
definition of disability stated in the policy is satisfied.
Some dishonest claimants may deliberately fake sickness or injury to collect from the
insurer.

!

Caution Even if the claim is legitimate, the insurer must still determine whether the
insured satisfies the definition of disability stated in the policy.
Sickness and disability are highly subjective, and the same event can affect two persons
quite differently.

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