Types of risk
Risk can be categorized into,
- Pure Risk
- Speculative Risk
Pure risk: Pure risk is a physical loss that the insured faces due to occurrence of a danger that has been insured against. Such a physical loss may be caused because of a halt in factory production, damage to a property arising from tire, accident and the like. Pure risks or risks of trade are such that they can seldom be avoided but can be insured against. Pure (static) risk is a situation in which there are only the possibilities of loss or no loss, as oppose to loss or profit with speculative risk. In other words these are the risks which may cause loss only and profits can never be expected out of such risks. The only outcome of pure risks are adverse (in a loss) or neutral (with no loss), never beneficial. Examples of pure risks include premature death, occupational disability, catastrophic medical expenses, and damage to property due to fire, lightning, or flood. Under such risks loss of property or person is probable and even in certain cases it may create liability on the property or person also. Pure risks can be further classified as:
- Property risk: This is the uncertainty associated with loss of wealth resulting from damage or destruction of property. For example, destruction of house property, factory, godown etc. destroyed by fire.
- Liability risk: This is the uncertainty related to financial instability that can arise from bodily injury including health) or loss of wealth that an individual or an organization causes to others. It is the risks which create financial liability on any person on the Occurrence of an uncertain event.
- Personnel risk: These consist of the possibility of loss of income or assets as a result of the loss of ability to earn income. This type of risk is associated with the loss to a firm as a result of death, incapacity, loss of health, prospect of harm to or unexpected departure of key staff. It is related with persons. Risk associated with human life due to illness, disease, unemployment, death, old age injury etc.
Speculative risks: Speculative risks are such that is faced by business or trade. This risk describes a situation in which there is a possibility of loss, but also a possibility of gain. The risk may include loss because of stagnancy of goods, goods being unsold due to war being declared or even if the product goes out of fashion. Risks is said to be speculative when there is possibility of profit or loss. Generally introducing a new product in the market is speculative.
Pure risks are risks that can be insured whereas speculative risks cannot be insured. Insurance can be the answer to many a risk management process. There are known risks as well as unknown risks. If you know the risks involved with a certain business or a certain situation, you may take a step to insure yourself against the said risk factors. Unknown perils cannot be insured against and you have no option but to face the situation.
The other classifications are,
Financial Risk: Financial risk arises from an individual’s or organization’s ownership or use of financial instruments. Financial risk is the chance amount involved when making investments. To ensure a great return on investments, risks should be limited and maintained at a low level. Investors who are planning to invest on stocks should explore the latest and past performance of the option before making an investment. Corporations that plan to purchase properties will also examine the business risk in terms of equity buildup. To ensure the stability of the business, adequate cash flow is also important because the property might not appreciate quickly. There are a number of economic factors that can give rise to financial risks including changes in interest rates, extensions of credit, issuance of stock, 1oreign currency transactions and the use of derivatives. Therefore, the extension of credit to customers by businesses such as credit card companies gives rise to the risk, financial risk, that some will default. Investment activities of individuals and the borrowing they undertake when making purchases of capital items such as cars, houses etc. also give rise to financial risk.
Non-financial (operational) risk: Non-financial risk, including operational risk, arises from the existence and activities of an individual or from the operations of an organization. For organizations, operational risk may arise directly or indirectly through inadequate internal processes, accounting, human error, systems or business continuity failures, fraud or inadequate legal and other documentation. An operational risk is a risk arising from execution of a company’s business functions. It is a very broad concept which focuses on the risks arising from the people, systems and processes through which a company operates. It also includes other categories such as fraud risks, legal risks, physical or environmental risks.
Static and dynamic risk: Static risk can be described as risk arising from damage or destruction of property and/or property that is illegally transferred as the result of misconduct of individuals. t involves those losses that would occur even if there were no changes in the economy. The risk is insurable. Dynamic risks are those resulting from changes in the economy. Dynamic risk results from exposure to loss from changes in the environment, such as changes in price levels, output, fashions, people’s tastes, and regulatory requirements. Dynamic risks are not insurable.