What is Risk?
Risk refers to a particular situation due to an uncertain or unexpected event. Every activity undertaken by individuals or organizations involves some kind of risk, which can lead to either positive or negative results. Unfavourable results can incur heavy losses; thus need to be taken care of and insured.
Risks can vary in degree and cannot be measured in advance. Some risks can be avoided, while some can be controlled. However, most risks are beyond the control of individuals and organizations.
Table of Content
When it comes to insurance, it is important to understand:
- What type of risk applies to which situation?
- What is the probability of a risk?
- What will be the degree of the risk?
- What can be the consequences of the risk?
No one can foresee the future. Therefore, the above questions are answered hypothetically. Negative as well as positive outcomes are anticipated and the situation which can result in a negative effect is insured.
Categories of Risks
Risk is diverse in nature and every kind of risk cannot be insured. Broadly, there are two types of risks.
Let us discuss these risk types in detail in the next sections.
A business is a commercial activity in exchange for which a business owner earns money. Every commercial activity carries a certain level of risk. However, every business owner needs to take risks to grow and survive in the competitive world. Avoiding risk is possible but eliminating it may keep the business far away from success.
Moreover, the more the risk is taken, the better the prospects of growth. Risk management deals with understanding the possibilities and severity of the risk and then developing a methodology to handle that risk efficiently. If the potential risk is recognized before time, it is possible to take precautions and plan economic ways to deal with it.
A business owner is generally not interested in taking any risk when it comes to the survival of the business. There can be many various types of risks in a business. Thus, to reduce the degree of risk, it is of utmost importance for an organization to identify the type of risk that it can be exposed to. The kinds of risks that can come ahead when business activities are undertaken.
Let us discuss these two types of business risks as follows:
Risks that emerge due to the internal operations of a business are called internal risks. In other words, internal risks arise while carrying out a business activity. Generally, these risks are foreseeable if there is a history relating to that risk in a business enterprise. The probability of internal risk can be determined to a certain extent. Thus, they can be managed and controlled to a considerable extent. Internal risks arise due to internal factors. These internal factors are:
- The human factor: It is just impossible to run a business without the presence of humans. However, it is the most significant cause of internal risks. Strikes by trade unions, accidents, careless attitudes toward work, and dishonesty are some major factors that affect work.
In addition, managerial disability and failure in following the appropriate methods of implementing various tasks and non-payment by creditors and debtors may also lead to unfavorable conditions for a business.
- Technological factor: Technological factors relate to the type of technology used in a business. The technique can become obsolete to give the expected results or can be too expensive to be implemented. This may increase the chances of internal risk.
- Physical factor: These factors can pose risks to physical elements, like goods, machinery, equipment, etc. Fire, robbery, and damage during transportation come under such type of risks as they may harm the physical asset of the company severely. Apart from this, compensation paid to a third party due to any kind of unintentional loss also comes under physical factors to bring internal risk.
Such risks originate due to the events arising out of a business organization and are beyond the control of the organization. Being uncontrollable, external risks cannot be predicted in advance. There can be a large number of external factors causing risk for the business. Some of these factors are:
- Economic factors: These factors are related to the economy and the current market condition. Examples of economic factors include changes in demand and supply in the market, fluctuating prices of raw materials, increasing competition, changes in the preferences of consumers and buyers, inflation, unemployment, changes in the global economy, etc.
- Natural factors: These factors are related to events that occur naturally in the environment. Mostly, these factors are natural disasters like floods, cyclones, tornadoes, earthquakes, lightning, or various other unknown changes in the environment.
- Political factors: These factors are related to the changes occurring in the political environment. These changes may occur in the policies for operating businesses, guidelines, market entry barriers, budget constraints, political scenarios, etc.
Personal risks directly impact an individual and his/her state of being and are about the existence and survival of an individual. Personal risks may be associated with the possibility of losing the job, reduction in income, risk of death or disability (that may make an individual unable to earn or take responsibilities), risk of poor health, etc. Broadly, four personal risks can affect an individual on a personal level:
- Death: An unfortunate event of death of a person can be devastating for his/her family. It is not only a loss for the family members, but also affects their financial well-being.
- Old age: Old age may cause the risk of unemployment for an individual. This may be due to the physical inability of a person that makes it difficult for him/her to work in old age.
- Poor health: The state of illness also causes the risk of expending a huge amount of medical bills. The risk is directly related to the financial well-being of an individual. Any kind of influence on an individual’s financial state may cause personal risk. Besides medical expenditure, the state of poor health for a long duration can cause the risk of unemployment as well.
- Unemployment: The state of unemployment is one of the major causes of personal risk. Unemployment restricts the way to livelihood which may further bring financial problems in the family.