| The idea that insurance companies are 'afraid' of risk | | | | suspect that there is some degree of speculation or |
| is a half-truth. The reality is that insurers avoid | | | | illegal wagering. |
| substandard risks or those that aren't considered | | | | 5) Lower premiums |
| insurable. Indeed, there are at least two sides to | | | | For insurance to be affordable, the risks must be |
| every story. An insurance company exists to provide | | | | kept at a satisfactory standard. Some risks are just |
| a service (risk coverage) but remain profitable. It is a | | | | too high for an insurer to accept- even at adjusted |
| business - not a charity. However, an insurer doesn't | | | | premiums. If a terminally ill patient seeks $100,000.00 |
| deny accepting risks or have deductibles and | | | | in life insurance, imagine what his premium may have |
| exclusions on a whim. There are several plausible | | | | to be for the insurer to not guarantee an |
| insurance-specific and business reasons for insurers to | | | | underwriting loss! Aversion from undue risk by |
| avoid certain risks. | | | | insurance companies helps to maintain lower premium |
| 1) Underwriting losses | | | | levels. |
| Insurance companies would experience significantly | | | | 6) Profitability |
| higher underwriting losses if they were not averse | | | | One should not fool oneself. Insurance companies are |
| from uninsurable risks or high risks. An underwriting | | | | in the business to make a profit. Before you view |
| loss occurs when an insurer pays out more money | | | | this as confirmation that insurance is a rip-off, |
| than received on a particular policy. So if you paid | | | | consider that most businesses exist to make a profit. |
| $4,000.00 for medical coverage and you get a claim | | | | However, insurance does this by being prudent while |
| paid for $30,000.00, your policy would be considered | | | | providing a necessary service for society. Being too |
| an underwriting loss. The aversion from high risk is to | | | | liberal with risks will affect an insurer's profit margins |
| reduce the likelihood of losses, since these affect the | | | | significantly. |
| stability of the company. | | | | 7) Duty to policy holders as a 'going concern' |
| 2) Anti-selection | | | | Depositors could make a 'run' on financial institutions |
| The tendency for those with greater risks to seek | | | | with swift, unexpected withdrawals that could leave |
| insurance coverage as opposed to those facing less | | | | an institution illiquid or insolvent. Too many |
| risk is broadly referred to as anti-selection. Insurers | | | | underwriting losses can lead to the winding up of an |
| have to be on the alert for those who may have | | | | insurer. An insurance company is a long-term business. |
| ulterior motives that are often undisclosed. Thus, the | | | | Risk selection is the key to sustaining this type of |
| application process is even more rigorous when higher | | | | business. Poor risk selection would lead to the winding |
| coverage levels are involved. Also, anti-selection is | | | | up of an insurance company. At that juncture, policy |
| also a reason for insurance companies employing | | | | holders would lose their money or the coverage that |
| concepts like deductibles, insurance excess and | | | | they paid for. |
| exclusions to manage the risk. | | | | 8) Adherence to sound insurance principles and |
| 3) Moral hazard | | | | policies |
| Moral hazard refers to the danger of dishonesty with | | | | The apparent risk-averse nature of insurance |
| an insurance transaction. Insurance companies may | | | | companies is not ad hoc. Insurers don't randomly |
| seem unwilling to accept certain risks if it is felt that | | | | reject business. They have policies in place that are |
| there is some dishonesty or non-disclosure involved. | | | | based on the characteristics of insurable risks and risk |
| It may seem as if the insurance contract states that | | | | assessment methods. |
| the insurance company does not cover more than it | | | | Insurers must discriminate in order for the company |
| actually covers. However, this is merely to reduce | | | | to survive. It is easy to suggest that insurers are |
| the moral hazard it faces through non-disclosure or | | | | 'afraid' of risk, but they are there to undertake |
| misrepresentation. | | | | insurable risks. Naturally, insurers have an issue with |
| 4) Preventing speculation | | | | substandard or risks or those that are too high for a |
| One insurance principle is that no one must gain from | | | | premium to be affordable or practical. Insurance |
| insurance. Even with life insurance, there is supposed | | | | companies are in the business of risk, but they must |
| to be some degree of parity between the sum | | | | be prudent and selective. It is this discretion (and the |
| assured and the economic value of the insured. | | | | lethargy of the claims process of some insurers) that |
| Insurance is an instrument of compensation. | | | | can unfairly create the notion that insurers are risk |
| Therefore, insurers may be apt to deny a risk if they | | | | averse. |