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Difficulty: HardElements of Insurable Risk

A technology startup submits an insurance application requesting coverage for the anticipated loss of future revenue if its highly experimental, unreleased prototype fails to secure a government patent. The underwriter must decline the application because it fails to meet several fundamental characteristics of an ideally insurable risk.

Which of the following required elements of an insurable risk are violated by this specific exposure? (Select all that apply)

  1. The exposure represents a chance for either financial gain or loss, failing the pure risk requirement.Answer
  2. The potential financial loss of anticipated future revenue is highly subjective and not definitely measurable.Answer
  3. The exposure lacks a vast pool of homogeneous units, making the probability of loss statistically unpredictable.Answer
  4. D
    The potential loss is entirely within the applicant's intentional control, violating the accidental loss requirement.
  5. E
    The exposure represents a catastrophic peril that would simultaneously cause profound financial loss to the insurer.

Answer

The exposure violates the requirements that an insurable risk must be a pure risk, possess a definitely measurable financial value, and have statistically predictable loss probabilities based on a large pool of similar units.
The scenario describes a speculative business venture, not a pure risk. Furthermore, future anticipated revenue for an unreleased product is subjective and impossible to measure definitely. Finally, a unique experimental prototype lacks the necessary historical data and homogeneous exposure units required to statistically predict the chance of loss.

Step-by-Step Solution

1
Analyze the nature of the proposed risk (securing a patent).
The venture involves the possibility of profit if successful, making it a speculative risk rather than a pure risk.
Insurance only covers pure risks (chance of loss or no loss), not speculative ventures.
2
Evaluate the financial measurability of the loss.
The loss is defined as 'anticipated loss of future revenue' for an unreleased product, which is entirely subjective.
An insurable risk must be definite in time, cause, place, and measurable in exact economic amount.
3
Assess the statistical predictability of the exposure.
A highly experimental, singular prototype does not belong to a large pool of homogeneous exposure units.
Without the Law of Large Numbers applied to similar exposures, actuaries cannot accurately predict the frequency or severity of the loss to establish an economically feasible premium.

Key Concept

To be considered insurable, a risk must be pure, definite and measurable, statistically predictable, not catastrophic, accidental, and part of a large number of homogeneous units.
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Elements of Insurable Risk

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