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The risk library  /  What a risk costs

Art. 01 · What a risk costs · 3 min read

Risk Cost: the £40 glass

Risk cost is what a loss would cost multiplied by how likely it is. It is the figure that makes a premium comparable to the risk it covers, and almost nobody calculates it.

There is a glass sitting near the edge of your kitchen counter. It costs £40 to replace. If it were certain to get knocked off this month, that glass is costing you £40 a month. You may as well have paid for it already.

Now suppose it is only a coin-flip: a 50% chance it goes this month. Half the time you pay £40, half the time you pay nothing. On average, £20 a month. Make it a 10% chance and the same reasoning gives £4 a month.

That is risk cost, and it is the foundation of everything else in this series. It is not a prediction that you will lose £4 this month. You will almost certainly lose nothing. It is the amount you should mentally set aside each month if you want, over a long stretch of months, to come out even.

Risk cost How much it costs, multiplied by how likely it is. Insurers call the annual version the expected annual loss. It converts "something might happen" into a number you can put next to a price.
A £40 GLASS · HOW LIKELY IT BREAKS THIS MONTH RISK COST PER MONTH Certain 100% chance £40 Coin-flip 50% chance £20 Unlikely 10% chance £4
Fig. 1 · The glass never changes. Only the chance does, and the risk cost moves with it in a straight line. A risk cost needs only two numbers: what it costs, and how likely it is.

The reason this matters is that it puts a risk and a premium into the same units. Until you have a risk cost, "£3,400 a year" is just a number on an invoice with nothing to compare it to. Once you have one, the question becomes answerable: is the price close to what the risk is actually worth, or a long way above it?

Scale it up and nothing changes. A commercial kitchen with a £180,000 fit-out and a one-in-forty chance of a serious fire in any year carries a risk cost of £4,500 a year from that peril alone. Same arithmetic, bigger glass.

£40,000
2.5%
Risk cost / year£1,000
Risk cost / month£83
Expect it aboutevery 40 yrs
Fig. 2 · Move either slider. The risk cost is just the two multiplied together; the waiting time is the other way of saying the same thing, and usually the one people find easier to feel.

Use it

  • List your five worst "what ifs." Not every risk: the five that would cost the most to put right.
  • Put two numbers on each. A replacement cost you would stand behind, and a rough annual chance. Rough is fine; a bad estimate beats no estimate.
  • Multiply, then compare. Set each risk cost beside what you currently pay to insure it. Some pairs will look sensible. Some won't, and those are your next conversation.

Want this run against your own numbers?

We put ranges, not single figures, against the risks your business actually carries.

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Explanatory content only. This article describes how insurance and risk decisions work in general terms; it is not insurance, legal, actuarial, or investment advice, and it is not a recommendation to buy, keep or cancel any cover. Every figure and diagram is illustrative, chosen to make a mechanism visible, not to describe any particular business.