Foundations of Risk Management and Insurance
Risk is uncertainty about outcomes. Pure risk (loss or no loss) is generally insurable; speculative risk (gain or loss) is generally not. Separate peril (the cause of loss: fire, wind, collision) from hazard (a condition that increases frequency or severity). Hazards come in three flavors: physical (icy steps), moral (deliberate dishonesty, such as arson or faked claims), and morale (carelessness because insurance will pay).
The risk management process
Identify loss exposures, analyze them by frequency and severity, select techniques, implement, and monitor. Techniques are avoidance, loss prevention (reduces frequency), loss reduction (reduces severity), retention, noninsurance transfer (e.g., contractual hold-harmless), and insurance. Exposures include property, liability, human resources (death, disability, retirement), and net income/business interruption.
What makes a risk insurable
Many similar exposure units; accidental, unintentional loss; determinable and measurable loss; no catastrophic concentration; calculable chance of loss; economically feasible premium. Adverse selection erodes these conditions (those most likely to lose buy the most coverage), which is why underwriting and classification exist. The law of large numbers requires numerous independent exposures; a hurricane striking one coastal region is highly correlated and defeats it.
Traps
Questions swap moral and morale hazard; label speculative risk insurable; or call an action "avoidance" when the exposure was retained but modified (that is loss control). Watch for funded retention versus noninsurance transfer.
Rule of thumb
Retain the frequent and small, insure the infrequent and severe, and aggressively control the frequent and severe.