A Look at Uninsurable Risk
Uninsurable risk refers to those things insurance companies won't cover. Knowing what is uninsurable will help you plan for the future.
In the insurance context, we look at risk to mean the chance of “financial loss”. This isn’t restricted solely to the loss of money—it could mean many things—including loss to health, property, or other assets.
If you get sick, you would face a financial loss due to medical bills or lost income if you are unable to work. Similarly, businesses could face financial losses if a trade secret was revealed or from having their reputation damaged in some way. The point is that there are a myriad of things that could result in a financial loss beyond the destruction or loss of property.
To deal with the risks individuals and businesses face on a daily basis, people turn to insurance to protect them. In exchange for a relatively small monthly premium, the insurance company promises to indemnify and protect insureds against potentially large and unknown losses in the future. Essentially, insurance gives you certainty.
Unfortunately, there are limits to insurance protections and it’s not always possible to protect individuals and businesses from every type of risk out there. Insurers call these uninsurable risks.
What is an Uninsurable Risk?
An uninsurable risk is a risk that insurance companies cannot insure (or are reluctant to insure) no matter how much you pay. Common uninsurable risks include: reputational risk, regulatory risk, trade secret risk, political risk, and pandemic risk.
The primary function of insurance is to spread risk across a wide area rather than keeping it concentrated. Insurance companies serve as the central point of control that administers this process. They collect premiums from many policyholders and use that money to pay the claims of a few policyholders. Insurance companies can only survive if claims do not occur too often. If the amount paid out in claims is consistently greater than the amounts received in premiums, then the company cannot survive.
Therefore, when the probability of loss is too high or the claims costs are too high on a particular risk, the insurance company may consider it uninsurable and exclude it from the policy. Let’s use a tangible example to help illustrate this point:
Take, for example, a health insurance applicant who has terminal cancer. The likelihood that is insurance company would have to pay is 100% and healthcare costs are expected to be very high. With no way to collect enough premiums to offset those high healthcare costs and still turn a profit, there is no choice but to decline this applicant as an uninsurable risk.
Similarly, you would be hard-pressed to find an insurance company willing to offer life insurance coverage to a 100 year old man. There is no way the insurance company could collect enough premiums in such a short time to offset the amount paid out. Accepting this applicant would mean burdening the pool of other insureds and drive premiums up for everyone else.
In order to avoid moral hazards (the idea that people will act more recklessly when they know they are covered by insurance,) illegal activities or willful acts are also uninsurable risks.
Insurance will not protect you or your business from criminal fines or penalties although some (i.e. cyber or privacy liability insurance) will cover some regulatory fines.
Types of Uninsurable Risks
There are a few reasons why a risk might be considered uninsurable:
There is the potential for catastrophic loss.
It is commercially uninsurable.
It is an uncommon loss.
It is the result of naturally occurring or cumulative damage.
Risks that are rare but could result in potentially massive losses are also excluded. While you might want to protect yourself and your business from every possible eventuality, some are just not insurable due to the sheer size. Insurers cannot possibly estimate the extent of damages and costs if war breaks out or, as we saw in 2020, the amount of business interruption and lost revenues from a global pandemic. Insurance companies can’t estimate the size of these losses but they know it would be too large to insure.
According to Canadian Underwriter, insurers globally collected US$30 billion in business interruption insurance premiums whereas the pandemic induced a US$4.5 trillion reduction in global GDP. That is nowhere near enough premiums to offset such a large loss. With their potential to destabilize or bankrupt an insurance company practically overnight, they are uninsurable.
That said, not all risks with catastrophic loss potential are excluded. Risks like earthquake, flood, or forest fires can result in catastrophic losses but they are insurable for an additional fee or by purchasing specific coverage.
Commercially Uninsurable Losses
Risks can be commercially uninsurable because they have the potential for catastrophic loss but another reason is simply that they’re illegal to insure. In many parts of the world, cannabis is still an illegal and highly controlled substance while it is fully legal in other areas. If an insurance company is subject to the rules and regulations of a government that considers cannabis illegal, they may not be able to insure those types of businesses. Similarly, if you were to insure a shipment of illegal goods, it would not be covered if the insurer discovers this fact.
While it might sound exotic, this type of uninsurable risk is more common than you might think. When was the last time you purchased something expensive like a watch or handbag while on vacation? Did you pay the tax on it when you brought it back? If you didn’t, your home insurance company might not cover that item. If you didn't pay the duty you owed, it counts as “illegally smuggled” into the country and therefore uninsurable.
If you recall, the function of insurance is to spread the losses of the few amongst the many. The role of the insurance company is to vet applicants and administer the pool of premiums so there’s enough to pay losses. If there are a few people in that pool with some uncommon risks, the other policyholders would be paying more to insure a risk that they didn’t technically need.
The solution is to exclude these types of risks altogether or create a separate product specifically for that subset of people so you’re not impacting the pricing and results of other policyholders that don’t have those unique risk exposures.
Many insurers have special pools for “high risk” individuals but policies are usually more restrictive and more expensive. This is common for drivers with poor driving histories or drive unusual vehicles.
Naturally Occurring or Cumulative Damage
Insurance is meant to protect you against unknown losses in the future that may or may not occur. Losses that are cumulative or naturally occurring are predictable and therefore do not fall under insurance protection. Some examples of naturally occurring or cumulative damage include: wear and tear, natural spoilage of perishable food items or discoloration of clothing on display in a store.
The Changing Insurance Landscape
The good news is that despite the conservative image that the insurance industry has in popular culture, it is always changing. As new risks emerge and demand develops, insurance companies develop new products to meet that demand and stay competitive in the marketplace.
For insurance, even just 10 years ago, cybercrime was a rare occurrence. Early hackers were mostly hobbyists doing it for the thrill rather than to cause damage or extort money from victims. Now, it is an entire industry run by states and organized criminal gangs. In response, the insurance industry now offers comprehensive cyber insurance coverage to protect businesses.
Outside of creating entirely new products, existing ones also change in response. Due to popular demand and changing societal expectations, Employment Practices Liability Insurance (EPLI) now covers sexual harassment, unfair work practices, and discrimination in the workplace based on religion, gender, or race. Previously, these issues were considered uninsurable.
If the risks you are concerned about are uninsurable, there are often government programs available. For example, many governments will offer you flood coverage if you are denied flood insurance from a traditional insurer due to your high-risk geographic location (flood zone or storm corridor).
Whether you’re looking for personal or business coverage, your best protection is a good agent or broker. They will work with you to perform a risk analysis to identify and address your risk exposures whether through insurance products or other risk management techniques if the risk turns out to be uninsurable.