PERIL

Peril is the cause of loss. Anything that causes loss is a peril.

An incident or an event which causes loss is called a peril
Examples of peril are Fire, Flood, Earthquake, lightning, Landslide Etc.

Insurance does not protect the asset or does not prevent the loss happening due
to a peril. Peril cannot be avoided through insurance. Insurance only tries to
reduce the impact of the financial loss due to a peril
Example : A person purchases fire insurance to make good the losses that might
arise due the fire . Here Fire is the peril. Purchasing fire insurance cannot prevent
the occurrence of the peril fire. But the occurrence of the peril Fire may be
reduced by installing smoke detectors and fire extinguishers in the office
premises. But still the occurrence of the peril fire cannot be avoided as it is not
under the control of the owner. In the event of fire occurring in the premises, the
loss suffered by the insured will be compensated by the insurance. Insurance
tries to put the insured in the same position that he was before the fire accident.

Insurance can compensate only the economic or financial losses. It cannot

compensate the non financial losses which cannot be measured or quantified in
term of money like the death of a person
Examples of non financial or non economical losses : Love and affection,
emotional loss and creative abilities. These are not quantifiable in monetary
terms.
Actual Losses and Consequential Losses

RISK
The term Risk is used to describe a situation where there is uncertainty about
what outcome will occur. So the risk is uncertainty of outcome. If there is a
chance that the outcome will be different from the expectations, then there is a
risk.
The term risk may also refer to the expected losses associated with a situation.
Risk is a measure of occurrence of a peril or an incident in terms of
frequency and intensity.
People staying in the hills are not exposed to the risk of tidal waves but they are
exposed to the risk of landslides. Similarly the people living near the seashores
are not exposed to the landslides but are exposed to the risk of tidal waves.

Risk may be defined as the possibility of adverse results flowing from any
occurrence.
Insurance will cover only those risks where the possibility of occurrence
is uncertain. If the possibility of occurrence of an event is certain, then
that risk cannot be insured.
Risks are possibilities not certainties and are measured by the loss that may
happen due to an insured peril
An office premises can be insured against fire since the event fire may happen or
may not. Suppose, if there is a forest fire nearby, then the office premises cannot
be insured against fire.
In life insurance, death is certain but the time of death is uncertain. Life
insurance compensates the loss due to death of a person though the death is
certain but the time of death is uncertain.
But a person suffering from cancer cannot be insured as his death is more
certain to happen at a short period of time.

The insurance company will compensate only if the insured suffers a

loss due to the occurrence of an insured peril.
For example, a person has insured the building and the contents in the building
against fire. There was a fire accident in the premises. But with the help of
smoke detectors, the fire was notices at the beginning itself and was put off with
the help of fire extinguishers and there was no damage to the properties. In this
case though the insured has purchased the fire insurance and there was a fire
accident. Since there was no loss suffered by the insured, the insurance
company will not make any payment against this policy. So the insurance
companies will make the payment only if there is a loss due to an insured peril.

Classification of Risks
Risks are classified into 5 broad categories

Catastrophic and Important risks :

Risks are classified based on the impact of damage or loss that an event or an
incident can cause. Catastrophic risks are those risks where a single
event leads to significantly higher damage or losses
Example : Earthquake, Tsunami
Important risks though are not catastrophic but may upset the family.

Example: Total Permanent or temporary disability, job loss due to economic

recession

Financial and Non Financial Risks

Financial risks are those risks which lead to losses that can be measured or
quantified in monetary terms.
Example : risks that are related to the changes in the value of the property. A
fire incident in the factory may destroy the goods and the extent of loss can be
measured in monetary terms

Non financial risks are those risks which lead to losses which cannot be
measured or quantified but still can be insured.
Example : The death of the bread winner of the family. Ailment of an individual
Mental agony or loss of reputation are non financial losses but can be insured.
The death of a patient due to negligence of a doctor is a non financial risk.
Non financial risks where the financial impact can be estimated can be insured
and vice versa.

Dynamic and Static Risks

Dynamic risks are those resulting from the changes in the economy.
Examples : Changes in the price level, Consumer tastes, Fashions, Technology

Static Risks are those losses that occur even if there is no change in the
economy.
Examples : Perils of nature and dishonesty of others

Pure and Speculative Risks

Speculative risks are those which are under the control of the persons
concerned. The outcome of a speculative risk can be either a loss or
gain.
Example : Horse race, Lottery

Pure Risks are not under the control of the person concerned. The
outcome of a pure risk could be a loss or no loss and definitely no gain
Example : Fire, Earthquake, Burglary, Death of a person and so on

Fundamental and Particular Risks

Fundamental risks are those which affect a lot of people
Example : Train accident which causes the death of many people. Moulivakkam
under construction building collapse.

Particular Risks affect only specified persons

Example : Burglary in a house, sudden death of the bread winner of the family

Sources of Risks
The types of risks faced by the individuals and businesses
Examples of business risks: Price risk, credit risk, Exchange rate risk, Interest
rate risk, Commodity price risk
Examples of Individual or personal risks: Earnings, Medical Expenses, Liability
Risk, Physical Assets, Financial assets, Longevity

Hazards
Hazard is a situation or a condition which creates, enhances or increases the
chances of loss in an insured risk. It is something that accelerates the peril.
Example : Explosives manufacturing unit
Types of Hazards : Physical Hazard, Moral Hazard and Morale Hazard
Physical Hazard :

Smoking is a physical hazard that may increase the chances of fire

accidents
Loose wire or open live wire in the house increases the chances of short
circuit and thereby fire accidents
The houses near the seashore are exposed to tidal waves and are physical
hazards
Ware houses string oils and crackers have physical hazards

Individuals having the history of diabetes and blood pressure have the
physical hazard relating to life insurance.

The probability of or chances of damage is higher in these cases and these

enhanced or additional risks can be measured and insurable
Moral Hazard : This refers to the character of the person approaching for
insurance
Dishonesty of persons approaching for insurance, Suppression of material facts
Morale Hazard : Indifferent attitude of the people having insurance, inflated
medical bill

Risk Identification
The purpose of risk management is to identify the risk and eliminate or
at least reduce the risk.
When there is a risk, there may be loss to the subject matter of insurance. The
total loss will include the following
1. Repair, Replacement or Reinstatement of the subject matter of insurance
2. Consequential losses until repair, replacement or reinstatement
The consequential losses may be
1. Expenses for cleaning up and removal of debris
2. Loss of rent, production, revenue, and profit until normalcy is restored.
3. Possible liability losses for third party injuries
The total loss that can happen is referred to as Maximum Possible Loss
(MPL).
The risk exposure is MPL multiplied by the probability of the peril striking. This is
called Probable Maximum Loss (PML)

Risk Management process

There are 4 ways to manage risks
1.
2.
3.
4.

Prevent / avoid
Reduce
Retain
Transfer

Prevention

Over speeding the motor vehicles, going to places disturbed by civil war
Palestinian, Syria and Iraq, visiting places affected with diseases like Ebola can
be avoided.
Taking much of precautions is also a method of prevention of risks Passenger
Aircraft with 4 engines, more than sufficient Fuel to reach the destination.
Reduction
Wearing helmet while riding motor bike,
Wearing seat belt while driving car,
Maintaining stocks of essential parts of machines during breakdown are the risk
reduction techniques.
Risks related to financial resources are fluctuations in the stock market,
Exchange rate fluctuations, and Political disturbances.
The industries use the following methods to reduce the risks
Early detection systems, Fire extinguishers, Automatic response to dangerous
situations through instrumentations, Mock drill to test the readiness of the
people and systems to meet the accidents.
Some of the loss reduction techniques are
Separation : Keeping the inventories at an isolated place, Carrying the
hazardous materials separately.
Display of Keep Away from instruction boards, No smoking zone
Duplication : Critical information or the important data in the systems are
backed up using external hard discs
Diversification : Spreading of risks across the areas which may not be affected
equally at the same time. Example Mutual Fund investments
Making products which are in demand in different areas and products for
different markets
Risk Retention and Transfer
These two risk management methods involve risk financing techniques.
When the loss due to a risk is minimal then the same may be retained. It means
that the loss due to the risk will be met out of our own funds. Or create a special
fund to meet the contingencies.
When the loss due to a risk is very high and very difficult to manage, then
transfer the risk.

Critical illness, Permanent disability death of the bread winner, Properties,

Liability and so on.
The popular risk transfer technique adopted by the people is Insurance.
In the case of life of an individual, there is an option to transfer the risk of
untimely death to an insurer by way of suitable life insurance policies or the risk
can be retained by the individual.
In this case let us analyse the consequences of retaining the risk and transferring
the risk.
If the individual decides to retain the risk by refusing to transfer it to an
insurance company, then in the event of unfortunate and unexpected death of
the bread winner, the surviving dependents will have to bear with the
consequences of loss of income.

The dependents may be required to dispose the assets such as

cars, motorcycles, jewels Etc.,
House wives may be forces to take up an employment to meet the
familys financial needs.
The family may need to move to a new less expensive dwelling
unit
The children may have to forgo their education in order to support
the family or shift to an inexpensive school.
The debts like home EMI, car EMI will suffer and may result in
losing out the property
In the case of a business man, the immediate problem would be
the demand of the debtors.

Had this individual transferred the risks to an insurer through proper life
insurance and Accident insurance plans, the family would have received
considerable cash flow to meet their needs fulfilled.
Reinsurance
Even the insurers do not undertake the risks which are beyond their capacity to
meet. The capacity of the insurer depends on their capital and reserves. Business
beyond their capacity is managed through reinsurance arrangements.
Summary

Peril is an event or an incident that may cause a loss. Examples of perils

are fire, flood, earthquake, lightning, landslide Etc.,
Insurance cannot prevent the occurrence of a peril or the loss due to the
peril. Insurance can only try to reduce the financial loss on the owner /
beneficiary\
Risk is uncertainty of outcome. If there is a chance that the outcome will
be different from the expected one, then there is risk

Risk can be classified as Catastrophic and important risks, Financial and

non financial risks, Dynamic and static risks, Pure and speculative risks,
Fundamental and particular risks.
Hazard is a condition or situation which creates or enhances the chances
of loss. It is something that accelerates the peril.
Hazards can be classified into Physical Hazard and Moral Hazard
Physical Hazards refers to the characteristics and qualities of subject
matter which is proposed for insurance
Moral Hazard refers to the character of a person approaching for
insurance.
The actual loss arising out of a peril includes cost of repair, replacement or
reinstatement and consequential loss until repair, replacement or
reinstatement
Methods of managing risks include Prevention of risk, Reduction of risk,
Retention of risk and transfer of risk
Loss reduction techniques include separation, duplication, diversification,
indemnity agreements and hedging
One of the popular methods of risk transfer is insurance
The individuals can manage the risk associated with their life by
transferring them to the insurance companies both life and non life
insurance companies.