Risk and Insurance

Chapter 1 is 12% of Paper 1 and sets the vocabulary for everything after it. Most questions here are short recall items, so the marks go to candidates who know the exact definitions.

Risk is uncertainty about a potential loss. Two things are uncertain: whether the loss will happen at all, and how much it will cost if it does. That uncertainty, and the fact that the loss is unwelcome, is what creates the demand for insurance.

A single event can cause three kinds of loss:

• •Financial: a loss you can measure in money, such as the cost of rebuilding a burnt shop. Damage to property is a financial loss.
• •Physical: death or bodily injury. It often brings financial consequences, such as lost earnings.
• •Emotional: grief, sorrow, distress.

Only financial and physical losses are normally commercially insurable. You can buy cover for a broken leg or a flooded flat; nobody sells cover for heartbreak.

Practitioners also use the word "risk" loosely. It can mean the uncertainty itself, the property or person insured ("this warehouse is a poor risk"), or the cause of loss insured against. In an "all risks" policy, risk means the peril: any loss from any cause is covered unless the cause is excluded.

Trap: examiners describe a damaged car and ask what kind of loss it is. It is financial, not physical. Physical loss is reserved for death and injury to people.

Takeaway: risk = uncertainty about a loss. Financial and physical losses are insurable; emotional losses are not.

Every risk is classified on two separate headings. Questions often mix them up, so keep the two tests apart.