If probability of risk is high, then insurance cover may not provide an escape route

what is insurance and the two kinds of risk. That is, pure risk and speculative risk. Speculative or investment risk is one where three outcomes are possible—gain, loss or status quo. Pure risk is one where only two outcomes are possible, loss or status quo. For example, a house can catch a fire or may not catch a fire. There is no third outcome possible. Insurance is a tool to manage pure risk. Risk management rules Firstly, don’t risk more than what you can afford to lose. Death of the sole earning member of a family jeopardises the entire family’s future. In such an event, sufficient life insurance is of prime importance. If occurrence of an untoward event is likely to be fatal, it is always prudent to obtain insurance against such an event. Second, one should always consider the odds of risk occurring. If probability of risk occurring is high, then insurance may not be a solution. Constructing a very large amusement park on very high earthquake zone may not be an ideal decision. In this example, either it will be difficult to find an insurer who is willing to insure the amusement park or the insurer may charge a very high premium. Thirdly, don’t risk a lot for too little. If the cost of replacing office furniture and fixture destroyed due to fire is Rs 10 lakh and cost of insuring furniture and fixture is Rs 425, then one must opt for insurance. Consider the financial impact if an untoward event occurs; then consider the cost of obtaining insurance for such an event. If the cost of acquiring insurance is low, you should always opt for insurance. Risk management techniques: Control and financing Risk Management can be ‘controlled’ in two ways: The first way is to avoid risk. For example, if a jeweller has a shop in an area where there is higher crime rate, then it is best to shift shop to a safer locality. This will ensure that risk of theft is avoided. The second way is to reduce the risk. The same jeweller can install theft alarms and appoint security guards to protect the shop. This will reduce the risk of theft to some extent. The other option is to ‘finance’ risk by ensuring that a procedure for this is in place if the risk cannot be controlled. Risk financing can also be done in two ways: a) Risk retention: If severity of financial loss due to occurrence of risk is not too high and where occurrence of risk is frequent, it is important to retain risk, e.g., nobody ever obtains health insurance only for common cough and cold. b) Risk transfer: This is nothing but insurance. In the event of an unfavourable event occurring, financial loss is transferred to the insurance company. Financial impact due to disability of a family’s earning member could be severe and, hence, there should be disability insurance for earning members. The financial loss suffered by the family due to disability is then transferred to the insurance company.