What it means
For a risk to be insurable it normally needs several features. The loss should be accidental from the policyholder's point of view, measurable in money, part of a large group of similar exposures, and not so widespread that everyone suffers at once.
A risk that fails these tests cannot be pooled in the usual way. Several examples are widely recognised.
Normal business risk, such as a new product failing to sell, is uninsurable because it is speculative, with a chance of profit as well as loss. Certain events, such as the ordinary wear and tear of equipment, are not accidental, and a loss that is certain to happen cannot be priced as a fair gamble.
Catastrophic risks are another group. If a single event can damage thousands of policyholders at the same moment, premiums collected in advance may not cover the claims.
That is why some war and nuclear risks are excluded from standard policies and are handled by governments or specialist pools instead. Businesses respond in several ways.
They can reduce the risk through better controls, retain it by holding extra cash or capital, transfer it through contracts, or use financial tools such as hedging for risks like currency and commodity price moves. A risk register that lists each uninsurable exposure and the chosen response helps the board see where the company is exposed.
The boundary is not fixed. As data improves or markets develop, risks once thought uninsurable can become insurable, as has happened with some cyber and weather-related exposures.
Even so, cover for these risks is often limited, expensive or subject to strict conditions. Boards sometimes confuse insurable risk with important risk.
A risk can be vital to the future of the company and still be one that no insurer will take, such as the loss of a key customer or a competitor launching a better product. Those risks are managed through strategy, diversification of customers and suppliers, and financial strength rather than through an insurance policy.
In practice
Real-world examples.
Example
A start-up launches a new fitness app and worries it may not attract subscribers. No insurer will cover that commercial failure, because the outcome could be a profit as well as a loss, so the founders set aside $150,000 of capital as a buffer.
Example
A manufacturer knows its ageing conveyor will wear out within two years. The cost of replacing it cannot be insured, because the loss is certain, so the finance team builds a replacement reserve of $25,000 a quarter.
Example
A coastal hotel group finds that cover for a rare type of widespread disaster is excluded from its standard policy. It buys a specialist policy for part of the exposure and keeps a contingency fund for the rest.
Case study
Seen in the real world.
Quillfeather Foods is an illustrative, fictional packaged-food maker that listed its main risks for the board. The list included product recalls, supplier failure, price swings in wheat and a possible collapse in demand for a new range.
The risk manager sorted each item by insurability. A recall and fire damage could be insured, but a drop in demand and the price of wheat could not, because both were speculative and affected the whole market.
The company hedged part of its wheat purchases with futures contracts and set a margin of safety in its budget for weaker sales. The illustrative result was a clear map showing which risks were passed to an insurer and which stayed with the company, which gave the board a more honest picture of its exposure. The same exercise showed that a quarter of the revenue came from a single customer, which led management to set a target of reducing that share over the next two years.
Watch out
Common mistakes.
- Assuming the company's insurance policy covers every business risk, when speculative and certain losses are normally excluded.
- Treating an uninsurable risk as one that can be ignored, when it still needs a plan such as reserves, hedging or risk reduction.
- Assuming a risk that is uninsurable today will stay that way, when new data and markets can make cover available.
Questions
People also ask.
What makes a risk insurable?
Generally the loss must be accidental, measurable, part of a large pool of similar exposures and not affecting everyone at the same time.
Is business failure ever insurable?
Not in the ordinary sense, because it is a speculative risk, although some narrow protections such as trade credit insurance cover specific causes of loss.
How can a company manage a risk it cannot insure?
It can reduce the likelihood, hold extra capital, use contracts or hedging, or accept the risk with a clear decision from management.
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