Concept of risk:

In insurance terms, risk is danger, peril, hazard, chance of loss, amount covered by insurance, person or object
insured. The risk is an event or happening which is not planned but eventually happens with financial
consequences resulting in loss..
Risk is considered the raw material of Insurance. Risks may injure Individual personally (i.e. premature death,
disability, disease, etc), injure his property (i.e. collision risk for his car, fire risk for his house, etc) or injure
his liabilities toward others (i.e. liabilities risks for owners' cars and owner’s ships and owner’s airplanes ….
etc).
After the knowledge of individual that his life exposes to many risks, he does not know, in advance the
outcome of any work does it. For example the person does not know his car will expose to accident in the
morning during his traveling to his work. The person does not know the time of his death … etc. Also the
person does not know he will have an accident or illness requiring hospital care. Of course he does not
know the answers of these questions, because he cannot predict the future with any certainty, that is, the nature
of risk, Ours is a world of countless risks, a world in which losses of many types happen suddenly and
expectedly. Hence, we can say the risk means uncertainty about future loss. In other words, the inability to
predict the occurrence of a loss

Definition of risk
authors who have concerned with risk and insurance (i.e. risk theorists, statisticians, economists, actuaries, law
men) have defined risk. So, there is no single definition of risk but there are a lot of definitions for example:
 REJDA has defined risk "Uncertainty concerning the occurrence of a loss"
 WILLIAMS, HEAD, HORN & GLENDENNING have defined risk" The possibility of loss"
 GREENE & TRIESCHMANN have defined risk"
 "Uncertainty as to loss" By study and analysis the previous definitions,

three elements existed in definition of risk, they are:

I) The probability of loss: That means if risk exists, it must be possible for loss to occur. Loss may or
may not occur under risk, but no risk exist when the probability of loss is either zero or 100% , and
that is 1 > probability > 0
II) Measurement of the probability of loss: That means, if the risk exists, the probability of loss should be
measured. For example, probability of death should be measured by quantitative techniques
(Mathematical and statistical methods) for premature death risk. Also the probability of fire should be
measured for fire risk and so on.
III) The financial loss: That means, if risk had occurred and there was loss. That loss should be financial
loss and applicable to be measured.
By taking the preceding elements into consideration, the risk may be defined from our viewpoint as
"Uncertainty as to an event that it results in financial loss, and it can be measured quantitative"
For example, the risk of premature death is existent, because uncertainty of time of death is present. The risk of
fire for factories is existent, because uncertainty is present and so on.
The risk may be:
A. Objective Risk or
B. Subjective Risk

A. Objective Risk or degree of risk

1. Defined as the relative variation of actual loss from expected loss

2. Declines as the number of exposure units increases
3. Can be measured by using the standard deviation or coefficient of variation
Example 10000 houses insured and 1% on average will burn ( i.e 100 houses). If 90 or 110 houses are burn
there will be variation . So that is Objective Risk

B. Subjective Risk

I. Defined as uncertainty based on one’s mental condition or state of

Mind
II. Difficult to measure
Example
If a driver is drinking heavily in a bar, he may be uncertain whether he will arrive his home safely without being
arrested by police for drinking. This mental uncertainty is called Subjective Risk.

Terminologies are related to risk

Some terms related with risk have rather precise meanings when they are used in connection with risk. These
terms are Chance of loss , Peril and Hazard. In order to avoid the confusion of persons between these terms
and the concept of risk discussed earlier, it is important to distinguish these terms as follows:

Chance of loss: is defined as the probability that an event will occur

Peril: A Peril is defined as " the direst cause of a loss" . People are surrounded by potential loss because the
environment is filled with a lot of perils such as collision, theft, accident etc". Examples of Peril:

a. If your car is damaged in a collision with another car, the collision is the peril or direct cause of loss.
b. If your flat is stolen, the theft is peril, or cause of loss. Commonly perils include collision, fire,
burglary, theft, explosion, hail, tornadoes, and earthquakes, epidemic, vandalism, windstorm. A single
peril may cause more than one type of loss. The collision of car with another can may result in some
killed persons and some others injured.

Hazard: A hazard is defined as "a condition that creates or increases the chance of loss due to a particular
peril". For example, Poor car brakes are a hazard making loss due to the collision peril more likely.
There are three types of hazard:
1. Physical hazard
2. Moral hazard
3. Morale hazard
 1. Physical hazard: is a physical condition that increases the chance of loss. In other words, the tangible
conditions of the environment that affect the frequency and severity of loss.

Examples of physical hazard:

 Poor car brakes - slippery roads that increase the chance of cars accidents.
 Defective wiring in house that increases the chance of loss.
 Icy roads (slippery roads).
 Defective lock on a door of house that increases the chance of loss - Dry forests.

2. Moral Hazard is the dishonesty or character defects in insured (Peron has insurance policy) that
increase the frequency and / or severity of loss. In other words, a moral hazard exists when the
insured person is one who may dishonestly cause loss. Generally, moral hazard exists when a
person can gain from occurrence of a loss.

Examples of moral Hazards:

o Creating an accident for a car to collect indemnity from insurance company.
o Creating an intentionally fire in an unsold insured merchandise to collect indemnity from insurance
company.
o Deliberately killing of the insured, to collect sum insured from insurance company
Moral hazard is existed in all types of insurance. So, the insurance companies try to avoid insurance in
situations where there is evidence of moral hazard. Also, insurance companies try to control moral hazard by
careful underwriting of applicants for insurance.

3. Morale Hazard is the attitudes of carelessness or indifference and lack of concern that increase the
frequency of loss and severity of loss which can occur, because of insurance. For example, Person who
instead of taking reasonable care of his insured house against fire risk, say "it is insured, so why should
I worry?" That is considered indifference (morale hazard) because of insurance.

Examples of morale Hazards:

o Careless cigarette smoking that increases the probability of loss by fire.
o Leaving car keys in an unlocked car that increase the probability of theft,
o Leaving a door unlocked of your flat increase the probability of theft, because it allows a burglar to
enter the flat.

Classification of Risks
Risks may be classified in many ways, but from our viewpoint we can classify the risks as either:
I. pure risks
II. speculative risks
 I. Pure risks mean the situations that result only in loss or no loss. One of the best examples for pure
risks is ownership of property for example ownership of a house will have a fire or it will not. Also
ownership a car will be stolen or it will not be. The possible outcomes are loss or no loss.
Premature death, flood ,lightining are considered other examples for pure risks

II. Speculative risks mean the situations that result in loss or gain. Gambling is a good example of a
speculative risk. In a gambling situation, risk is deliberately created in the hope of gain. A person
who bets on ball games may either loss or wins. Business venture involve many speculative risks.
The investment made by a person in stock of exchange may be lost if the prices of shares and bounds
had decreased, but this risk is born in return for the possibility of profit (i.e. if the prices had risen).

Classification of risks
The distinction (difference) between pure risks and speculative risks is important because normally only pure
risks (situations in which there is no chance of profit) are insurable. The insurance is not concerned with the
protection of individuals against those losses arising out of speculate risks, because the latter has two-
dimensional (the possibility of loss - the possibility of gain) .Hence speculative risks are not insurable. So we
can shed light upon pure risks as follows:-
Pure risks
Pure risks that exist for individual and business companies can be classified into 3 types, they are:

a. Personal risks are risks that directly affect an individual .They involve that possibility of loss
of income or assets as a result of the loss of the ability to earn income.
There are five major personal risks:
 Premature death risk
 Disability risk
 old age risk
 Sickness risk
 Unemployment risk

b. Property risks are risks that affect not on individual but they affect his/her property. That is,
any person owns property (car – house – ship – airplane …. etc) is exposing to property risks.
Simply because such possessions can bedestroyed or stolen. For example car can be damaged
or destroyed because of collision. Also, Real estate and personal property can be destroyed or
damaged because of fire, windstorms, Tornado, lightning and numerous other causes.
Property risks involve two types of loss
i. Direct Loss
ii. Indirect or Consequential loss.
The previous two types of property risks can be determined by this example: If your house is destroyed by
fire, you lose the value of the house, this is a direct loss. Over the time required to rebuild your house,
you will charge additional expenses for living somewhere else by paying, a rent for other flat. This loss of use
of the destroyed house is indirect loss.

c. Liability risks: By virtue of these risks a person can be held legally if he does something that
result in bodily injury or property damage to other person. Consequently, the court may order
the person to pay substantial damages to the injured person. The liability risks may result from
intentional or unintentional injury of other persons or damage to their property through
negligence or carelessness

Examples of liabilities risks.

In fact, our life has many liabilities risks i.e.:
 Motorists can be held legally liable for negligent operation of their vehicles
 Business firms can be held legally liable for defective products that harm or injure customers
 Engineers, accountants and other professionals can be sued by clients because of alleged acts of
malpractice
 Physicians ,and pharmaceutics, can be sued by patients because of alleged acts of malpractice.
Liabilities risks are of great importance for two reasons:
 There is no maximum upper limit with respect to the amount of the loss. That is, the negligent person
who causes accident that result in serious bodily injury to other driver, he can be sued for any amount
100.0000 L.E., 200.0000 L.E or million or more.
 Legal defense costs can be enormous. In particular, if the person has no liability insurance, the cost of
hiring attorney to defend him can be staggering.

Other Classifications for Risks

1. Diversifiable Risk and Nondiversifiable Risk: A diversifiable risk ( particular risk) affects only
individuals or small groups (car theft). It is also called nonsystematic or particular risk.
A nondiversifiable risk( fundamental or general risk) affects the entire economy or large numbers of
persons or groups within the economy (hurricane). It is also called systematic risk or fundamental risk.

2.Enterprise risk encompasses all major risks faced by a business firm, which include: pure risk,
speculative risk, strategic risk, operational risk, and financial risk
 Strategic Risk refers to uncertainty regarding the firm’s financial goals and objectives.
 Operational risk results from the firm’s business operations.
  Financial Risk refers to the uncertainty of loss because of adverse changes in commodity prices,
interest rates, foreign exchange rates, and the value of money.
Alteration of the risk

The risk that the event insured against will or will not happen necessarily depends on the subject-matter of
insurance and its attendant circumstances, and the insurers, in accepting the insurance, are guided by the state of
the subject-matter and the circumstances existing at the date of the policy.
The description inserted in the policy of the subject-matter and its circumstances, therefore, serves to define the
risk undertaken by the insurers, and any alteration made during the currency of the policy which affects the
subject-matter or its circumstances as so described is an alteration of the risk since the state of facts
contemplated by the insurers no longer exists in its entirely.
There, is, however, no alteration of the risk where an alteration, though apparently on the face of it an alteration
of the risk, is not a real alteration of the risk at all, but such an alteration as, on the true construction of the
policy, might be taken to have been within the contemplation of the parties at the time when they entered into
the contract.
Nor is there any alteration of the risk where the alteration does not affect the description in the policy, even
though it increases the danger of loss, since the risk as defined in the policy remains the same.

Alterations of the risk fall into three classes:

1. Alterations in the subject-matter of insurance;
2. Changes of locality;
3. Changes of circumstances, such as, for instance, in the user of the subject-matter on in the trade or
business carried on by the assured.

A. THE EFFECT OF AN ALTERATION

Sometimes the effect of an alteration is that the policy ceases to apply. This occurs where the identity of the
subject-matter is destroyed.
In other cases the effect is that the operation of the policy is merely suspended.

1. Where the policy ceases to apply

Where the alteration destroys the identity of the subject-matter as described in the policy, there is not so much
an alteration of the risk as the substitution of a different risk; the policy, therefore, ceases to apply in as much as
the insurers have never undertaken the new risk.
Thus, in a burglary policy, a description of the locality, in which the property insured is situated, may form a
necessary part of the description of the subject-matter, as, for instance, where property insured under a general
description is described as being in a particular house or shop. In this case the property, on its removal from the
specified locality, ceases to answer the description and the policy no longer applies.
Similarly, in fidelity insurance, a description of the employee’s office or duties may from a necessary part of the
description of the subject-matter, and apart from any condition in the policy, a change in the office or duties
described may involve the substitution of a different risk which the policy was not intended to cover.
A motor policy is usually identified with a particular vehicle, although the insured may be protected when he is
driving another vehicle. But when the vehicle is sold, the insured is no longer covered whilst driving another
vehicle.
In accordance with the same principle, a change in the constitution of a firm, or a change of business, may
deprive the assured of his portion.
Where, on the other hand, the identity of the subject-matter is not affected, an alteration of the risk, whether in
the subject-matter, its locality or circumstances, has, in general, no effect on the policy, and it is immaterial
whether the assured is responsible or not for the alteration, or whether the alteration increases the danger of loss
and, in fact, conduces to the loss. Any such alteration made during the currency of the policy is renewed;
otherwise the renewal is void.
But although the alteration of the risk does not affect the identity of the subject-matter, the policy may still be
avoided where:
a. The alteration is in breach of good faith, as, for instance, where it is made fraudulently with intent to defraud
the insurers.
b. The alteration is a breach of a condition subsequent of the policy.

2. Where the alteration merely suspends the operation of the policy

There are certain cases in which the alteration does not affect the validity of the policy, but merely suspends its
operation whilst the alteration continues. These cases are:
a. Where there is an express condition of the policy to that effect.
b. Where it is the intention of the parties that the policy should be suspended only, and not avoided.

a. Express condition in the policy

Thus, a motor vehicle policy may contain a condition suspending its operation whilst the vehicle is under repair;
or an employers’ liability insurance may be suspended whilst the insured’s employees are on strike.
b. Intention that the policy should be suspended only
A policy which is intended to cover accidents happening only in a particular locality or in particular
circumstances necessarily ceases to attach upon a change of locality or circumstances, as the case may be.
If, subsequently, the original position is restored, a question may arise, in the event of an accident happening in
the original locality or in the original circumstances, whether the alteration has put an end to the policy or
merely suspended it during the continuance of the alteration. The answer to the question depends on the
construction to be placed upon the language of the particular policy.
If the language used amounts to a condition alteration, the policy is avoided and does not reattach when the
original position is restored.
In some cases, however, it is clear from the nature of the subject-matter that the alteration must have been
within the contemplation of the parties, and the policy accordingly reattaches. Thus, if horses are insured whilst
in a stable, their removal from the stable suspends the operation of the policy, but it reattaches on their return.
Similarly, an insurance against liability for accidents, whether to workmen or third persons arising out of work
carried on at particular premises, does not cover accidents happening in consequence of work carried on
elsewhere; but the fact that work may be carried on elsewhere does not affect the validity of the policy as
regards accidents happening upon the premises specified.

B. IMPLIED CONDITIONS AS TO MAKING ALTERATIONS

The description in the policy of the subject-matter usually includes statements as to locality, user, or other
circumstances, which are not required for its identification, and an alteration in the circumstances described
does not, therefore, prevent the subject-matter from being identified.
It is necessary to consider with what object such statements are inserted in the policy, and how far they prohibit
an alteration in the circumstances describes.
The following cases may be distinguished:
1. Where the policy contains an express condition against alterations.
2. Where there is no express condition against alterations.

1. Where the policy contains an express condition against alterations

Where the policy contains an express condition against alterations, the statements in the description define the
risk undertaken by the insurers and furnish the standard by which any subsequent alterations are to be measured.
They are not in themselves contractual; if they are accurate at the time of insuring, the assured has discharged
his obligation and is not precluded by their presence in the policy from making alterations. Any alteration,
therefore, to be prohibited, must fall within the scope of the express condition; any other alteration may be made
with impunity.

2. Where there is no express condition alterations

Where there is no express condition against alteration, the effect of a statement in the description depends upon
whether it is to be construed as a mrer representation or as amounting to a contract that the circumstances shall
remain as described throughout the duration of the policy.
A statement in terms referring to the future, if construed as a mere representation, is a representation of an
intention honestly entertained at the date of the policy and nothing more; it does not prohibit the assured from
changing his intention and thereby bringing about an alteration in the circumstances describes.
If, on the other hand, the statement is construed as contractual, it is an undertaking by the assured that the
circumstances shall continue as described, and any alteration therein is prohibited.
A statement not in terms referring to the future, if construed as a representation, is fulfilled at the date of the
policy and is not affected by any subsequent alteration; if, on the other hand, it is contractual, it must be
construed as co-extensive with the risk, unless there is something to limit its duration, and any alteration in the
circumstances described must, therefore, be regarded as prohibited during the currency of the policy.
Whether in a particular case the statement is a representation or contractual is a matter of construction, to be
determined with reference to all the circumstances of the case; the fact that it is inserted in the policy does not
prevent if from being construed as a representation.
A statement expressing a future intention, or a statement which merely assists in the identification of the
subject-matter, or which adds a detail to its description or is otherwise a natural adjunct of the description, is, in
the absence of anything pointing to a contrary conclusion, to be regarded as a representation.
If, however, the statement does more than amplify the description of the subject-matter and adds a description
of circumstances which it is unnecessary to mention unless the statement is intended to be contractual, it is
difficult to avoid the conclusion that it was so intended, since there is otherwise no apparent reason why it
should have been inserted in the policy, and it must therefore be construed as prohibiting any alteration in the
circumstances described during the currency of the policy.

C. EXPRESS CONDITIONS AS TO MAKING ALTERATIONS

The policy usually contains a condition by which the making of subsequent alterations affecting the subject-
matter is either prohibited altogether or more or less restricted.
The effect of the condition depends on its terms. Usually, the policy is avoided by a breach of the condition; but
in some cases it is so framed as merely to suspend the policy whilst the alteration continues. Where the policy is
avoided by the breach, it is immaterial to consider, in case of loss, whether the loss is attributable to the
prohibited alteration or not, since the policy has ceased to be operative.
By the terms of the condition the effect of the breach is usually limited to the property affected by the alteration;
otherwise, the policy may be avoided as a whole.
The policy is not, however, avoided ab initio, the avoidance takes effect only from the time of the breach. The
assured therefore remains entitled to enforce the policy in respect of any claim which has already arisen.
There is no breach of condition if the alteration which is made is not of such a character as to be covered by its
terms, since such conditions asr strictly construed. Where, however, the alteration is, in fact, a breach of the
condition, the purpose for which it was made, or the fact that it was made without the assent or even the
knowledge of the assured, cannot be taken into consideration.

The prohibition or restriction may be confined to a particular class or classes of alterations specified in the
policy, or may be so wide as to cover alterations of any nature whatsoever.

The different forms which the condition may take may be classified under the following heads:
a. Conditions prohibiting alterations absolutely.
b. Conditions prohibiting increase of risk.
c. Conditions prohibiting alterations without notice.
d. Conditions prohibiting increase of risk without sanction.

(a) Conditions prohibiting alterations absolutely

By such a condition the making of alterations is prohibited absolutely. The prohibition may be:
i. General, extending to any alteration whatsoever; or
ii. Qualified, prohibiting alterations of the kind or kinds specified.
In either case the making of prohibited alteration avoids the policy, and it is immaterial that the alteration is of a
trivial character, or that it does not increase the risk, provided that it falls within the scope of the condition.
(b) Conditions prohibiting increase of risk
By such a condition the making of such alterations as increase the risk is prohibited. Provided that the identity
of the subject-matter remains, the assured is not precluded from making any alteration, however extensive, so
long as the risk is not thereby increased; for until there is an increase of risk, the condition cannot be broken.
Whether any particular alteration increases the risk is a question of fact, and must be proved by the insurers.
Whether any particular alteration increases the risk is a question of fact, and must be proved by the insurers.
To establish a breach of condition it is not, however, sufficient to show that the risk has been increased. The
question remains whether the alteration falls within the terms of the particular condition employed.

Two classes of such conditions are to be distinguished:

i. Conditions which are so widely framed as to embrace any alteration whatsoever, and to avoid the policy,
whether the alteration increasing the risk is permanent or temporary.
ii. Conditions which contemplate alterations of a permanent character only. Under such a condition a mere
temporary alteration does not avoid the policy, even though it increases the risk and, in fact, causes the loss.
(c) Conditions prohibiting alterations without notice
By such a condition the making of alterations is prohibited unless notice is given to the insurers.

Two classes of such conditions are to be distinguished:

I. in which the prohibition is general in its terms, amounting to an asolute prohibition of alterations
without notice
In this case any alteration, however immaterial, is, in the absence of notice, a breach of the condition, and
avoids the policy.
The fact that it is of a temporary character or that the risk is not increased thereby cannot be taken into
consideration.
II. Conditions which define the classes of alteration which are not to be made without notice
No notice need be given when the alteration made does not fall within its terms; for in this case neither
the alteration nor the failure notice avoids the policy.

A. TIME FOR GIVING NOTICE

The time when the notice should be given, whether before or after the alteration is made, depends on the
particular condition. The terms of the condition may be such as to permit of the notice being given after the
alteration has been effected; in this case, unless the condition specifies a time within which the notice is to be
given, it will be sufficient if given within a reasonable time. If notice is given within the requisite time, there is
no breach of the condition, and the assured may recover, notwithstanding that the loss may have taken place
after the alteration and before the notice. It is for the insurers to prove the absence of notice.

B. SANCTION OF THE INSURERS

The condition may provide not only for the giving of notice, but also for obtaining the sanction of the insurers
to the alteration. There may also be an express provision that such sanction must be obtained before the
alteration is to be made; or the terms of the condition may contemplate the giving of the sanction afterwards.
The assured cannot safely make any of the prohibited alterations without first obtaining the sanction of the
insurers, unless the condition clearly contemplates that such sanction may follow the alteration. Even in this
case it is more prudent for him to obtain it first. The sanction of the insurers may be refused altogether, or may
only be granted in consideration of an increased premium. If, notwithstanding the refusal of the insurers, the
alteration is persisted in, the condition applies and the policy is avoided by the making of a prohibited alteration.
The policy will similarly be avoided where the sanction is given in consideration of an increased premium, if
such premium is not paid, since the terms upon which the sanction has been given have never been performed,
and the sanction has therefore never taken effect.
Where, however, the condition provides that a breach is to avoid the policy only as regards that part of the
subject-matter insured which is affected by the alteration, the policy will remain in force as to the remainder;
but the insurers may, to meet such a case, by the terms of the condition, reserve the right to terminate the whole
insurance effected by the policy.
The assured is not bound, on obtaining the consent of the insurers and paying the increased premium, if any, to
make the alteration at once; unless a time is prescribed by the insurers, he may make it at any time during the
currency of the policy. The condition may provide that the sanction of the insurers is to be signified by a
memorandum indorsed on the policy. The insurers may, however, waive the necessity for this memorandum, or
may be stopped by their acts or conduct from relying upon its absence.
 C. Conditions prohibiting increase of risk without sanction
By such condition, which is the one usually employed in practice, the prohibition is confined to the making of
such alterations as increase the risk, and at the same time the obligation is imposed upon the assured of
obtaining the sanction of the insurers.
To avoid the policy, therefore, it is necessary to show not only that the alteration in question increases the risk,
but also that the sanction of the insurers has not been obtained. The condition usually provides that the sanction
is to be signified by indrosement on the policy. This provision is an important factor in determining whether the
particular condition avoids the policy in the case of alterations other than those of a permanent character.
Where, after an alteration increasing the risk has been sanctioned by the insurers, and duly indorsed on the
policy, a second alteration is made which, though increasing the original risk, does not amount to an increase of
risk compared with the alteration sanctioned, the policy is probably avoided.
Refrences

1. Mutthy, K.S.N, and Sarma, K.V.S. Modern Law of Insurance, 4 Th Edition. Haryana: Lexis Nexis
Butterworth Wadhwa, 2009.
2. Http://www.nordicplan.org.
3. http://www.noic.ac.in.
4. http://www.businessmanagementideas.com.