Meaning of Risk 風險的意義
Risk is uncertainty about whether a loss will happen, when it will happen and how large it will be. It has two elements: uncertainty, and the possibility of loss. If a loss is certain to occur, such as wear and tear from ordinary use or the depreciation of machinery over time, there is no uncertainty, so it is not a risk in the insurance sense.
Distinguish a peril from a hazard. A peril is the direct cause of a loss, such as fire, typhoon, theft or collision. A hazard is a condition that increases the chance of a loss or makes a loss more severe. A hazard does not cause the loss directly.
Hazards fall into two types. A physical hazard comes from the physical features of the subject matter, for example a building of timber construction, flammable chemicals kept in a warehouse, or a ground-floor shop in a low-lying area that floods easily. A moral hazard comes from people's behaviour and attitudes, for example dishonesty, exaggerated claims, or a careless approach to preventing loss because insurance is in place.
When underwriting, an insurer assesses both types of hazard. It may then decline the risk, charge a higher premium, impose an excess or add special conditions. Exam scenarios often ask you to identify which factor is the peril and which is the hazard, and whether the hazard is physical or moral.
Classification of Risk 風險的類別
Financial and non-financial risk: a financial risk has an outcome that can be measured in money, such as the cost of repairing a damaged car. A non-financial risk cannot easily be measured in money, such as choosing the wrong career or buying something you end up disliking. Insurance deals only with financial risks. One event can involve both: grief at the death of a family member is non-financial, but the loss of the household's income is financial.
Pure and speculative risk: a pure risk has only two possible outcomes, loss or no loss, as with fire, theft or a traffic accident. A speculative risk can result in a loss, no change or a gain, as with trading shares, gambling or expanding a business. Insurance normally covers only pure risks, because a speculative risk carries the chance of gain and is a commercial choice the person makes voluntarily.
Fundamental and particular risk: a fundamental risk is impersonal in origin and widespread in effect. It can affect society as a whole or large groups of people and is largely beyond any individual's control, for example war, inflation, mass unemployment or a severe earthquake. Such risks have traditionally been seen as the responsibility of government and society, and insurers often exclude them or cover them only on limited terms. A particular risk is personal in origin and local in its consequences, for example a fire in one flat or a collision involving one person's car. It is the individual's own responsibility and is the type of risk most commonly insured.
These categories are not fixed. In Hong Kong, typhoons and flooding affect wide areas, yet property and household policies commonly cover them, often as an extension or under all-risks cover. This shows that a fundamental risk can be insured on suitable terms.
Risk Management 風險管理
Risk management is a systematic way of identifying, evaluating and controlling the risks that could threaten a person or an organisation, so as to keep losses as low as possible at a reasonable cost. The basic steps are: (1) identify the risks, for example through site inspections, checklists and past loss records; (2) analyse and evaluate them by measuring frequency (how often losses occur) and severity (how much each loss costs); (3) choose and put in place control methods; and (4) monitor and review on a continuing basis.
Control methods are either physical or financial. Physical control includes avoidance, which means not carrying out the activity at all (for example, stopping production of a high-risk product), and reduction. Reduction covers loss prevention (for example, a no-smoking rule or a burglar alarm) and limiting the size of a loss (for example, automatic sprinklers or fire doors).
Financial control includes retention and transfer. Retention means bearing the loss yourself. It may be deliberate, as with self-insurance or accepting a higher excess, or unintentional, where a risk was never identified. Transfer means passing the financial consequences of a loss to someone else. Insurance is the main method of transfer, but contract terms can also shift liability to a contractor or supplier.
As a general rule, a low-frequency, high-severity risk such as a major factory fire is best transferred by insurance. A high-frequency, low-severity risk is better retained and reduced. Where both frequency and severity are high, avoidance should be considered, and where both are low the risk can be retained. In Hong Kong the law requires certain risks to be transferred by insurance: the Employees' Compensation Ordinance (Cap. 282) requires employers to insure their employees against work injuries, and the Motor Vehicles Insurance (Third Party Risks) Ordinance (Cap. 272) requires third party risks insurance for motor vehicles.
Practice
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