Page 40 - Insurance Times June 2023

Basic Elements of

law of probability

or law of large

numbers R. Venkatesan
BA BGL AII DIL

insurance

Insurance companies use this definition because they can only cover such a loss with the payment
of money. A loss differs from an expense, which is an expected payment for a good or service.
Thus, buying gas for your car is an expense, while a car accident is a loss.

Relative Probability to Risk: It also denotes an object that is a cause of risk, or a person or
property that would be risky to insure. Thus, a heavy drinker
The risk, as defined in insurance, is the possibility of a loss.
would be a risk as a driver, or a wooden building would be a
The obverse of this definition is that risk is the possibility of no
poor risk for fire insurance. The profitability of any insurance
loss. If there is no possibility of loss, then there is no risk.
company depends on how well it can predict losses; thus,
Likewise, if loss is a certainty, then again, there is no risk,
assessing risk requires the accurate calculation of the
even if the outcome is undesirable. Thus, the probability of a
probability of losses.
loss must be between 0 and 1, not inclusive. However,
sometimes risk cannot be measured. Because insurance
Relative Probability to loss:
premiums are determined by expected losses, risks that
However, most insurable risks cannot be calculated using
cannot be measured cannot be insured.
deduction, because there are too many variables with varying
degrees of influence on the probability of a loss. For these
Loss can be broadly defined as an undesirable outcome or as
cases, only induction can be used to however, most insurable
a less desirable outcome. If you have the choice to buy 2
risks cannot be calculated using deduction, because there
stocks, and the one that you bought goes up less than the
are too many variables with varying degrees of influence on
other one, then you did not suffer a loss, but you did incur an
the probability of a loss. For these cases, only induction can
opportunity cost. On the other hand, if, as you cross the street, be used to assess the objective probability of an insurable
you get hit by a truck, then that is an undesirable outcome. risk, by recording a large number of observations under a
Both of these cases illustrate a type of loss, but the opportunity given set of conditions, where the actual number of losses
cost is not insurable. are recorded against the number of possible losses.

Only risk is insurable, but not every risk. Only economic loss Generally, the term loss is used to denote the absence of
that can be compensated by the payment of money is something previously possessed, such as lost time or lost
insurable, and only if expected losses can be ascertained. opportunities as well as economic losses, such as a lost wallet.

36 June 2023 The Insurance Times