Subjective Risk
What Does Subjective Risk Mean?
Subjective risk is the perceived chance of something negative happening based on a person’s opinion, emotions, gut feeling, or intuition. It is not a mathematical assessment but rather a quick evaluation influenced by the individual’s feelings at the time. For example, a superstitious person might avoid flying on Friday the 13th due to the subjective risk they perceive.
By definition, subjective risk varies from person to person, as it is heavily influenced by personal bias. This type of risk is not grounded in hard data and is highly flexible. Personal beliefs or life experiences can shape someone’s perception of how likely an event is to occur. While subjective risk can often be explained rationally, predicting it accurately is not feasible.
This contrasts with objective risk, where the analysis and probability of a loss event are based on statistical analysis or observations from a large amount of historical data.
Insuranceopedia Explains Subjective Risk
Insurance companies avoid using subjective risk in their decision-making due to the lack of evidence supporting such assessments. Additionally, subjective risk varies greatly from person to person, making it difficult to develop a consistent business plan.
Instead, insurance companies rely on objective risk, which is the mathematical probability of a problem occurring. Rather than relying on feelings or superstition, they focus on analyzing and assessing situations based on empirical data.
Given the long history of most insurers, they have access to vast amounts of historical data on natural disasters and various types of businesses, which they use to estimate risk. According to the law of large numbers, the more data points you have, the more accurate your predictions are likely to be.
This data is typically analyzed by actuaries and consultants. The results are compiled into an underwriting manual, which provides guidelines on what types of risks underwriters should accept or decline, how to rate different types of risks, and more.
These manuals ensure that underwriters act rationally and maintain consistency, supporting the organization’s business plan and goals.
However, underwriters and brokers—who handle frontline underwriting with clients—often still use subjective risk or their “gut instinct” when deciding whether to accept new business. This is especially common when dealing with risks in emerging industries or new types of business, where there is insufficient historical data to base decisions.
In such cases, underwriters may rely on more subjective data points, such as how applicants respond to questions, to assess the level of risk involved.
