Sarah is organizing a large outdoor music festival. She purchases an insurance policy to cover potential financial losses if a severe thunderstorm forces the cancellation of the event. Separately, she decides to book an unproven, experimental headliner, hoping this bold choice will dramatically increase ticket sales, although it could also result in poor attendance and severe financial loss. Which of the following statements correctly classifies the risk exposures Sarah faces according to fundamental insurance principles?
- ABoth the thunderstorm and the booking decision are classified as pure risks, because both involve a significant possibility of financial loss that can be insured.
- The thunderstorm is a pure risk because it offers only a chance of loss or no loss, while booking the experimental headliner is a speculative risk because it presents a possibility of financial gain.Answer
- CBy purchasing insurance for the thunderstorm, Sarah is practicing risk avoidance, whereas the headliner decision represents risk retention.
- DThe thunderstorm is considered a physical hazard that guarantees a loss, while the unproven headliner is a peril that merely increases the likelihood of a loss.
Answer
The thunderstorm is a pure risk because it offers only a chance of loss or no loss, while booking the experimental headliner is a speculative risk because it presents a possibility of financial gain.
The correct answer accurately distinguishes between pure risk, which involves only the chance of loss or no loss (the potential thunderstorm), and speculative risk, which includes the chance of both gain and loss (the business decision to book the headliner). Traditional insurance is designed to cover only pure risks.
Step-by-Step Solution
Key Concept
Definition and Types of Risk (Pure vs. Speculative)