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Difficulty: EasyDefinition and Types of Risk

Insurance is designed to protect against specific types of exposures, focusing exclusively on situations where there is only a chance of loss or no loss at all. Which of the following scenarios represents a pure risk?

  1. A family faces the possibility that their primary residence could be severely damaged by a windstorm.Answer
  2. B
    An investor purchases shares of a startup company in anticipation that the stock price will rapidly increase.
  3. C
    An entrepreneur opens a new restaurant in a busy downtown area hoping to generate substantial profits.
  4. D
    A sports fan places a financial wager on the final outcome of a professional basketball game.

Answer

A family faces the possibility that their primary residence could be severely damaged by a windstorm.
The scenario describing potential windstorm damage is a pure risk because the homeowner can only experience a loss (damage to the property) or no change (no damage). There is no opportunity for the homeowner to profit from the windstorm.

Step-by-Step Solution

1
Define pure risk.
A pure risk is a situation in which there are only two possible outcomes: loss or no loss, with no potential for financial gain.
Understanding the definition is necessary to evaluate the given scenarios.
2
Define speculative risk.
A speculative risk involves the possibility of loss, no change, or financial gain (e.g., gambling, investing, starting a business).
This helps eliminate incorrect options that represent situations with a chance of profit.
3
Evaluate the scenarios based on the definitions.
Investing in stock, opening a business, and gambling all offer a chance for financial gain, making them speculative risks. The possibility of windstorm damage offers no chance for gain, only the potential for loss.
Applying the definitions to the options identifies the only pure risk.

Key Concept

Pure vs. Speculative Risk
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Topics

Definition and Types of Risk

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