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Express Units - Risk
Have you ever wondered why car insurance is more expensive for some people?
Or why holiday insurance costs more if you go on an adventure holiday?
It’s all to do with risk, insurance companies charge you more if they think it’s
more likely that you will make a claim.
They calculate the risk by looking at how likely it is something will happen, such
as you crashing you car – let’s hope not very likely!
But how do you calculate the risk of crashing your car? Well, you look at probability.
Probability is about the chance of something happening.
When we talk about how probable something is we say things like ‘unlikely’,
‘never’, ‘maybe’ or ‘definitely’, how many people have you heard say “I’ll
probably never win the lottery’?
When you think about how probable something is you look at the facts and
then do an assessment. For example, you want to go out for the day and
don’t know whether it’s going to rain. You might take a peek out the window
to look at the sky. If it’s cloudy you’ll make a judgement that it’s ‘probably
likely’ to rain and take an umbrella.
You can also talk about probability using numbers, everything on the probability
scale goes from zero to one.
If the likelihood of something happening is never, such as it snowing for a
whole year, we say it has the probability of zero.
If the likelihood of something happening is certain, such as celebrating your
birthday in the next year, we say it has a probability of one.
If the probability of something is 50-50, or a half, we say it has an even
chance. Such as when you toss a coin, it could either land on heads or tails.
Everything else comes somewhere in-between on the probability scale.
If it comes between impossible and 50-50 it is likely to not happen.
If it comes between 50-50 and certain, it is likely to happen.
But why is it important to know about probability with your money?
Well it’s because insurance companies are interested in probability when
thinking about risk.
When you take out insurance you are protecting yourself against a possible loss.
So you might take out insurance for your car, holiday or even life insurance.
When you apply for insurance the insurance company has to decide how likely the
thing you want to insure against will happen. If you want to insure your car,
but you regularly drive about 2000 miles a month you’re more likely to
have a crash, than if you only drive to the local supermarket at the weekend.
The more likely the thing you want to insure against will happen, the higher
the insurance will cost. The amount the company charges you is called an
insurance premium. This is because it’s more likely that the insurance company
will have to pay out.
This is why young drivers have such high car insurance costs. If you’ve only
just learnt to drive, you are more likely to crash your car!
Risk and probability also comes into play when you want to save or invest money.
Say you had a £100 and you wanted to put it somewhere in the hope that
it would grow in value and make some money for you.
Well, there are lots of different ways in which you could save or invest this
money, but some will be riskier than others.
One option would be to invest your £100 in companies on the stock market.
Here you can get a higher return, but it is riskier as it’s impossible to predict
which companies will hit the big time and which companies will hit rock bottom.
There’s a strong sense of uncertainty here.
On the one hand you could invest your £100 in a company that goes from
strength to strength and whose profits keep rising, and find yourself with
a nice little nest egg.
But on the other hand, you could invest in a company that goes bust and
find yourself losing all your money.
Taking a gamble isn’t everyone’s cup of tea, so you might decide that
opening a savings account is the best option for you.
If you open a savings account at the bank and put the £100 in there, they
will pay you interest on your savings. But, while your savings are likely to
grow, you are not likely to get rich quick from the interest.
It’s up to you, can you afford to gamble for a higher return – but remember
you might lose all your money!
- Probability is about the chance of something happening.
- For car insurers if they think you’re a high risk they will charge you
a higher insurance premium. The higher the probability of something
happening will mean you are more likely to make a claim.
- Taking out an insurance policy doesn’t remove a risk, but provides you
with some financial security should the worst happen.
- Think about risk when investing and saving money. The higher the risk,
the higher the potential return. But a higher risk also means you’re more
likely to lose it all too.
- Attitudes to risk vary and different people will be comfortable with different
levels of risk for different amounts of money.