Definitions and concepts of risk

The word ‘risk’ has a number of meanings, and it is important to avoid ambiguity when risk is referred to. One concept of risk is uncertainty over the range of possible outcomes. However, in many cases uncertainty is a rather crude measure of risk, and it is important to distinguish between upside and downside risks.

Risk can also mean the quantifiable probability associated with a particular outcome or range of outcomes; conversely, it can refer to the unquantifiable possibility of gains or losses associated with different future events, or even just the possibility of adverse outcomes.

Rather than the probability of a particular outcome, it can also refer to the likely severity of a loss, given that a loss occurs. When multiplied, the probability and the severity give the expected value of a loss.

A similar meaning of risk is exposure to loss, in effect the maximum loss that could be suffered. This could be regarded as the maximum possible severity, although the two are not necessarily equal. For example, in buildings insurance, the exposure is the cost of clearing the site of a destroyed house and building a replacement; however, the severity might be equivalent only to the cost of repairing the roof.