CLASSIFICATION OF RISKS & TYPES OF

RISKS
Classification of Risks
• Catastrophic Risks
• Financial Risks vs Non Financial Risks
• Dynamic Risks vs Static Risks
• Pure Risks vs Speculative Risks
• Fundamental Risks vs Particular Risks Etc.,
Catastrophic Risks
Climate change,
Pandemic
Nuclear terrorism
Bioterrorism
Nuclear war
Global economic contractions
cosmic gamma ray bursts, and asteroids,
Floods, Earth Quake - Natural Disasters
Non Financial Risks
• Model Risk.
• Operational Risk (fraud, misconduct, failure of internal controls
or audit systems, natural disasters)
• Settlement risk.
• Accounting risk (changes in GAAP/IFRS and comparability
issues, managed earnings, etc.)
• Regulatory risk.
• Legal risk (counterparty does not honor a contract)
Dynamic Risks vs Static Risks

• Economic risks are considered dynamic when they are

difficult to predict and occur as the result of sudden
changes. For example, a change in fashion trends or
government regulations could qualify as a dynamic risk for a
clothing company.
• Static risks are often associated with a commodity the value
of which will not be affected by an economic change. It even
further presumes that the financial state is, more or less,
stable. Static risks include damage caused by human
behavior, such as theft, vandalism, robbery, arson, and
burglary
Pure Risks vs Speculative Risks

• Speculative risks involve the possibility of loss and gain. Pure

risks involve the possibility of loss only.
• Pure risk is a type of risk that cannot be controlled and has two
outcomes: complete loss or no loss at all. There are no opportunities
for gain or profit when pure risk is involved. Pure risk is generally
prevalent in situations such as natural disasters, fires, or death.
• Speculative risks are not insurable because the lure of the
possible reward causes people to take these risks upon themselves
willingly. The possibility of gain is a moral hazard (more on that later)
that makes people seek out the risk, rather than avoid it.
Fundamental Risks vs Particular Risks
• Fundamental risk affects a large number of people or even all of the
population. Particular risk involves losses that are personal in origin and
effect. It affects an individual or a small number of people. For example,
a traffic accident occurs and two pedestrians suffer severe injuries.
• Exposure to loss from a situation associated with specific individual
events, such as a break-in, fire, or robbery. Particular risk are usually
insurable.
• Exposure to loss from a situation affecting a large group of people or
firms, and caused by (a) natural phenomenon such as earthquake, flood,
hurricane, or (b) social phenomenon, such as inflation, unemployment,
war. Fundamental risks may or may not be insurable.
Types of Risk
• There are different types of risks — only some are preventable, and
only certain types of risk are insurable. Risk can be categorized as to
what causes the risk, and to whom it affects

• Pure risk is a risk in which there is only a possibility of loss or no loss

—there is no possibility of gain. Pure risk can be categorized as
personal, property, or legal risk. Pure risk is insurable, because the law
of large numbers can be applied to estimate future losses, which
allows insurance companies to calculate what premium to charge
based on expected losses
• Static and dynamic risks are distinguished by their temporality.
• The possibility of loss is uniform over an extended period of time for
static risks, so static risks are more predictable, and, therefore, more
insurable.
• Dynamic risks change with time, making them less predictable and
less insurable. For instance, the risk of unemployment changes with
the economy, so it is difficult to predict what unemployment will be
next year. On the other hand, the number of houses that burn down
within a given year within a specific geographical area is steadier, not
cyclical, and so is more predictable
• Personal risks are risks that affect someone directly, such as illness,
disability, or death. Property risk affects either personal or real
property. Thus, a house fire or car theft are examples of property risk.
A property loss often involves both a direct loss and consequential
losses. A direct loss is the loss or damage to the property itself. A
consequential loss (indirect loss) is a loss created by the direct loss.
Thus, if your car is stolen, that is a direct loss; if you have to rent a car
because of the theft, then you have some financial loss—a
consequential loss—from renting a car
• Legal risk (liability risk) is a particular type of personal risk that you
will be sued because of neglect, malpractice, or causing willful injury
either to another person or to someone else's property. Legal risk is
the possibility of financial loss if you are found liable, or the financial
loss incurred just defending yourself, even if you are not found liable.
Most personal, property, and legal risks are insurable
• Speculative risk differs from pure risk because there is the possibility of profit or loss, such as
investing in financial markets. Most speculative risks are uninsurable, because they are undertaken
willingly for the hope of profit. Also, speculative risk will generally involve a greater frequency of
loss than a pure risk, since profit is the only other possibility. So although many people take
precautions to protect their lives or their property, they willingly engage in speculative risks, such as
investing in the stock market, to make a profit; otherwise, a person could avoid most speculative
risks simply by avoiding the activity that gives rise to it
• The speculative risk of investments can also be distinguished as systemic risk (systematic risk) or
diversifiable risk (unsystematic risk). Systemic risk affects the whole economy, causing the value of
many financial instruments to lose value. Diversifiable risk, on the other hand, affects only specific
investments, such as particular stocks or particular assets. It is called a diversifiable risk because
this risk can be minimized by diversifying investments, by not putting all your eggs in one basket. By
contrast, systemic risk cannot be diversified away, because it affects almost all investments.
Systemic risk can be minimized if the investments are diversified and held long enough, since the
value of most investments, like businesses, goes through cycles.
• Unlike pure risk, where there is only possibility of a loss, society
benefits from speculative risks. For instance, investments benefit
society, and starting a business helps to create jobs and generate tax
revenue for society, and can lead to economic growth, or even
technological advancement.
• Risk can also be classified as to whether it affects many people or only a single individual.
Fundamental risk is a risk, such as an earthquake or terrorism, that can affect many
people at once. Economic risks, such as unemployment, are also fundamental risks
because they affect many people. Particular risk is a risk that affects particular
individuals, such as robbery or vandalism. Insurance companies generally insure some
fundamental risks, such as hurricane or wind damage, and most particular risks. In the
case of fundamental risks that are insured, insurance companies help to reduce their risk
of great financial loss by limiting coverage in a specific geographic area and by the use of
reinsurance, which is the purchase of insurance from other companies to cover their
potential losses. However, private insurers do not insure many fundamental risks, such as
unemployment. These risks are generally insured by the government, because the
government has some control over economic risks through specific policies, such as
monetary policy, and law. Fundamental and particular risks can be pure or speculative
risks
• Fundamental risks are risks that affect many members of society, but fundamental risks
can also affect organizations. For instance, enterprise risk is the set of all risks that affects
a business enterprise. Speculative risks that can affect an organization are usually
subdivided into strategic risk, operational risk, and financial risk. Strategic risk results
from goal-oriented behavior. A business may want to try to improve efficiency by buying
new equipment or trying a new technique, but may result in more losses than gains.
Operational risks arise from the operation of the enterprise, such as the risk of injury to
employees, or the risk that customers' data can be leaked to the public because of
insufficient security. Financial risk is the risk that an investment will result in losses.
Because most enterprise risk is speculative risk, and because the enterprise itself can do
much to lower its own risk, many companies are learning to manage their risk by creating
departments and hiring people with the express purpose of reducing enterprise risks—
enterprise risk management. Many larger firms may have a chief risk officer (CRO) with
the primary responsibility of reducing risk throughout the enterprise
Thank You

Jaswanth Singh G
Insurance (InsureTech), Banking & Pensions Domain
Consultant and Faculty
Innovator @ indiaassurance.in and allinsuranceclaims.in
Resident Editor The Insurance Times
+91 8310765785 +91 9449049107 
[email protected]