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What is Speculative Risk? And why is it not insurable?
By Kyle Hatchett
 

 

Since insurance is all about defending against risk, I think we should talk a little more about what risk is and what kinds of risks there are.

Last week, I gave you a brief, working  definition of insurance:

Insurance is a way to transfer financial risk away from you and on to somebody else.

But you may be thinking, "If I buy a lottery ticket or play at a casino, that's a financial risk. I may win money, or I may lose money. Could I get insurance on that?

That's a good question, and the short answer is no. You can't insure gambling, because gambling is speculative risk. (If you're interested in a longer answer, ask me about hole-in-one insurance. It is possible to insure some games of chance, but that's a conversation for another day.) Insurance protects against pure risk, not speculative risk

What is speculative risk?

Speculative Risk

Like I said, the financial risk involved with gambling is called speculative risk. Speculative risk is when there is a possibility for financial loss or gain, not just for loss. This comes from the word speculate, which means to "invest in stocks, property, or other ventures in the hope of gain but with the risk of loss".

You and I take speculative risks every day. Sure, some people buy lottery tickets (I don't.). Many people buy stocks in the hopes that they can sell them later at a higher price. But even the more risk-averse among us take little speculative risks. For example, we check our email a little too often, just in case the email might contain something more interesting or important than what we're already working on (It usually doesn't.). We go to our favorite restaurant and order something that we've never had before, just in case it might be good (and it often is). We risk a little bit of embarrassment when we go up and ask that person for his or her name again, even though we should have remembered it last time we heard it. Maybe that person will be offended, or maybe asking for a name again will show that person that we care and are interested in deepening the relationship.

In all of these cases, we put something valuable at risk (maybe money, but often just time and effort) in the hopes of gaining something better than what we gave in exchange. Sometimes this speculative risk pays off, and sometimes it doesn't. That's why it's called a risk. 

But why isn't this kind of risk insurable?

Speculative risks are not insurable because the lure of the possible reward causes people to take these risks upon themselves willingly. The possibility of gain is a moral hazard (more on that later) that makes people seek out the risk, rather than avoid it. It's why we wouldn't sell a car insurance policy to someone who was into drag racing. They know that they risk injury and damage to their car, but the adrenaline and the possibility prestige might cause them to drive unsafely. Insurance is made to protect against accidents, but, if you go looking for trouble and you find it, can you really call that an accident?

So what kind of risk is insurable?

In contrast to speculative risk, insurance protects you from pure risk. What is pure risk? More on that next week.
Posted 9:29 AM  View Comments

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