THE CONCEPT OF RISK

It would seem that the term risk is a simple enough

notion. When someone states that there is risk in a

particular situation, the listener understandswhat is

meant: that in the given situation there is uncertainty

about the outcome, and the possibility exists that

the outcome will be unfavorable. This loose, intuitive

notion of risk, which implies a lack of knowledge

about the future and the possibility of some

adverse consequence, is satisfactory for conversational

usage, but for our purpose a somewhat more

rigid definition is desirable.

Economists, statisticians, decision theorists, and

insurance theorists have long discussed the concepts

of risk and uncertainty in an attempt to construct

a definition of risk that is useful for analysis

in each field of investigation. So far, they have

not been able to agree on a single definition that

can be used in each field. A definition of risk that

is suitable for the economist or statistician may be

worthless as an analytic tool for the insurance theorist.

Because each group treats a different body

of subject matter, each requires a different concept

of risk. Although the statistician, the decision

theorist, and the insurance theorist all use the

term risk, each may mean something entirely different.

Insurance is still in its infancy as a body of

theory. As a result, we find contradictory definitions

of risk throughout the literature dealing with

this phenomenon from an insurance point of view.

One reason for these contradictions is that insurance

theorists have attempted to borrow the definitions

of risk used in other fields. Surprising as

it may seem, insurance text writers have not been

able to agree on a definition of this basic concept.

To compound the problem, the term risk is used

by people in the insurance business to mean either

a peril insured against (e.g., fire is a risk to which

most property is exposed) or a person or property

protected by insurance (e.g., many insurance companies

feel that young drivers are not good risks).

In this text, however, we will use the term in its general

meaning, to indicate a situation in which an

exposure to loss exists.