How is insurance different from other financial services?

When you’re talking about the “Finance” industry most people will immediately think of a bank, or a stock broker, or even a wealth manager.

In fact, if you played a Family Feud style game, on the list of answers regarding the types of companies operating inside the finance industry, “insurance” will be somewhere close to the bottom (if it appears on the survey at all).? But insurance is a financial service even if it does not have much in common with an institution like a Bank - which loans out money and operates on the basis of every-day, short term use for its customers.

Risks and their Management

One of the first and most important things to understand in relation to finance is that every single financial product and company deals with some form of risk —but not all risks are the same or even equal.

Risks are normally divided into two separate categories.

A pure risk is one in which a party will experience a loss, or have no change in their current circumstances.

Pure risks exist everywhere and can happen at any time.

Cargo falling off a container ship, an electrical outlet causing a house fire, or car accident or all examples of pure risks. These are things which are going to happen and leave you in a worse situation than before.

In contrast to pure risks are speculative risks.

Under a speculative risk there is the possibility for either a loss or a gain – you may, after dealing with the risk, be in a better position than you were before the risk was realized. Types of speculative risk include gambling, or purchasing stocks, or may other types of business activities where it is possible to end up with a profit.

While it is possible to obtain insurance which includes some form of speculative risk (investment-linked life insurance, for example) most risks taken by the majority of Hong Kong and International Insurance Companies will deal solely with pure risks. This is due to the fact that pure risks are normally undesirable, and speculative risks can be extremely attractive depending on the situation and people involved. Consequently, people will enter into speculative risks, voluntarily, and for financial gain.

If insurance existed to cover the risk of the speculation not occurring, then there would be no reason for the parties involved in the speculative risk to achieve their desired outcome – whatever happened, whatever the risk, they would always be insured.

However, having said this, in some cases it is possible to insure a speculative risk alongside a pure risk. A good example of this would be the inclusion of Producer’s Profits cover on an Event Contingency Insurance policy.

The world of insurance is extremely wide, so there will be exceptions to most rules.

Exploring Risks: Cause and Effect

Risk is at the primary concern of all insurance, and unlike Banks or other financial services, when insurance refers to “risk” it is usually dealing with a pure risk. But even more than that, insurance needs to fully understand how a risk will play out, and consequently further goes on to separate pure risks into two distinct categories, Particular Risks and Fundamental Risks.

Particular Risks are limited in their scope and consequence – they will impact only a select person or specified, manageable group of people. While a particular risk can be serious, involving the loss of large amounts of money or causing someone’s death, their impact will not be widespread. A manufactured battery exploding and causing bodily injury would be an example of a particular risk, as would something like a traffic collision.

On the other side of particular risks exist Fundamental Risks.

A fundamental risk is one which develops beyond the control of any single person or group, and which will have a widespread impact on society. Fundamental risks include things like terrorist attacks, natural disasters and catastrophes, wars and famines, and other problems which would be considered “societal” issues.

For most consumers the insurance products they deal with will be particular risks – car insurance, home insurance, even Employees’ Compensation Insurance are all examples of particular risks. If coverage is offered against a fundamental risk, it is usually only provided on the impact that fundamental risk will have on a limited population.

Event Contingency Insurance is again useful as an example here, as it is possible to obtain coverage against the fundamental risk of a pandemic, or communicable illness, forcing a cancellation of an event. While epidemics and pandemics would normally be excluded from a majority of different forms of insurance coverage due to the wide-reaching impact of the disease outbreak, in the specific instance of a pandemic cancelling a covered music show or sports tournament, the producers would be insured.

For many other types of financial services companies, the type of risk is not important – and an understanding of the impact of how the financial services will be required due to the development of a risk are not normally provided. This focus on, and classification or risk, helps insurance to offset potentially negative outcomes – equitably.

Insurance Equity – Balancing the Contract

The strict definition of insurance is:

The equitable exchange of risk for a predetermined fee.

For an insurance product to qualify as an insurance product a number of things have to be happening. Firstly, there must be a risk that can be exchanged, secondly a fee must be paid and money transferred, and finally, the contract must be equitable – no one party involved must be better off than the other.

This concern of equity make insurance fundamentally different to many other financial products which, when place alongside the fact that a customer is protected from a negative risk, means that insurance is actually far more focused on the impact of the customer than most of the financial services industry.

A bank, for example, takes customer money so that it can loan it out, while charging an interest rate, and make a profit. In contrast to this a “pure” insurance company takes a premium, holds it, and then guarantees that it will be able to financially compensate the involved parties should a claim be made. While it is likely that an insurance company will make a profit on claims it does not pay from policyholders who do not experience the realization of a risk, the simple existence of insurance guarantees that when a claim does materialize, it will be paid.

Your Insurance and CCW Global

Insurance is a financial service – money is exchanged and a service is provided. Consequently, all insurance companies, affiliates, and intermediaries are also financial services organizations. But, while all finance companies deal with money, insurance isn’t interested in ensuring that customers profit (except in the very limited instances of investment linked products).

The main difference between insurance and other types of financial product is the focus of the insurance industry towards myriad risks.

CCW Global is an independent insurance broker. Founded in 2012 and headquartered in Hong Kong, we work with leading international insurance companies, and help to empower our customers to make informed decisions on the protection they need. From corporate risks to personal lines, our expert insurance advisors will work with your key stakeholders to offer industry leading benchmarking and analysis services – so you are assured of only purchasing the coverage you need.

Contact CCW Global Today and arrange a free, no-cost, no-obligation consultation for your business.

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