Subjective Risk

Published: | Updated: November 6, 2020

Definition - What does Subjective Risk mean?

Subjective risk is the perceived chance of something bad based on a person’s opinion, emotions, gut feeling, or intuition. It is not a mathematical review of the situation, but rather a quick assessment based on a person's feelings at the time. For example, a superstitious person might skip a flight on Friday the 13th because they see a subjective risk.

Subjective risk, by definition, differs from person to person as it is heavily dependent on personal bias. This type of risk is not based on any hard data and is highly flexible. Personal beliefs or even life experiences can have an effect on someone’s perception of how likely an event actually is. Oftentimes, subjective risk can be explained rationally but predictions of subjective risk can not be made accurately.

This is opposed to objective risk where the analysis and probability of a loss event occurring is based on a statistical analysis or observations made on a large amount of historic data.

Insuranceopedia explains Subjective Risk

Insurance companies try to avoid using subjective risk to make their decisions because of the lack of evidence supporting this kind of assessment. Moreover, the level of subjective risk differs widely from person to person so it does not allow for a consistent business plan.

Instead, insurance companies look at objective risk to make their decisions, which is the mathematical chance of a problem occurring. Instead of relying on feelings or superstition, they rely on analyzing and assessing situations empirically.

With most insurers having existed for so long, they have a huge amount of historical data on natural disasters and all types of businesses they can use to estimate risk. According to the law of large numbers, the most samples and data points you have, the more accurate the predictions are likely to be.

This data is usually analyzed by actuaries and consultants. The results of this analysis is collected in an underwriting manual which contains guidelines on what types of risks underwriters should accept and decline, how to rate different types of risks, and more.

These manuals ensure that underwriters are acting rationally and help ensure consistency to achieve the business plan and goals of the organization.

That said, underwriters and brokers (who are tasked with frontline underwriting on the client) still often use subjective risk or their “gut instinct” when deciding whether to accept a new piece of business or not. This is especially true when working on risks that are in new or emerging industries where underwriters and insurers do not have a large database of historical data to base their decisions off of.

In these instances, underwriters need to use other more subjective data points such as the way applicants answer questions, etc. to determine the amount of risk inherent in this piece of business.


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