Oasis Textile Mills decides to spend $1.5 million upgrading its production facility with an unproven, high-speed automated loom system. Management recognizes that this new equipment could either significantly increase profit margins or fail completely, resulting in severe financial deficits. Furthermore, because the new looms generate excessive friction, the facility's overall likelihood of experiencing a catastrophic fire has increased. How would these different exposures be classified under standard insurance definitions?
- The loom investment is a speculative risk, and the excessive friction is a physical hazard.Answer
- BThe loom investment is a speculative risk, and the excessive friction is a peril.
- CBoth the loom investment and the fire exposure are pure risks because they carry the potential for substantial financial loss.
- DThe decision to use unproven equipment is a morale hazard, and the potential for a fire is a speculative risk.
Answer
The investment in the unproven loom system represents a speculative risk, while the excessive friction generated by the equipment represents a physical hazard.
The financial investment represents a speculative risk because it involves a conscious business choice that could result in either a profit or a loss. The excessive friction represents a physical hazard because it is a tangible, physical characteristic of the operation that increases the frequency or severity of a potential loss (the fire).
Step-by-Step Solution
Key Concept
Distinguishing between pure and speculative risks, and differentiating hazards from perils.