Whether dealing with auto, health or liability insurance, both the insurer and the policyholder are weighing risk. While the policyholder is looking to limit the risk to his finances, property or loved ones, the insurance company is betting against the risk. In fact, there are several types of risk which different types of insurance companies deal with.
When the risk is either all or none, it is called a pure or static risk. Pure risks are straight bets, and most insurance companies deal in these kinds of bets. This is because there are only two possible outcomes for the risk of insuring the person or property: either the risk will pay off, or it won't. This design is obviously at work in policies, such as life or flood insurance. These policies only pay off in the event of total loss of the insured item. The benefit of pure risk policies to the policyholder is a potentially large payoff in the event of a catastrophe; the benefit to the insurance company is the likelihood that the policy will remain active, and premiums will continue to be paid.
When an individual is personally affected by the risk involved, this is known as personal risk. Personal risk is the basis behind a wide variety of insurance types, including unemployment, health, homeowner's and renter's insurance. This is also where policyholders find the most ambiguity in their policies. Losses in a personal risk policy do not have to be total; and because the chances of at least a partial payout of the policy are good, many insurance companies look to specify the circumstances under which a loss is covered by the policy. For example, a health insurance policy may cover cancer treatment but only if that treatment falls within certain guidelines.
Fundamental risk is one that involves the entire community. These types of risk include high inflation, stock market crashes, high instances of unemployment and widespread natural disasters. Insurance companies occasionally find themselves wrapped up in these types of fundamental risks (e.g., the homeowner's insurance companies were entangled in debts to homeowners from hurricane Katrina for years), but most fundamental risks must be insured by government agencies. Stock market crashes and bank runs are a good example of fundamental risks handled by government agencies, such as the Federal Reserve Bank.