What is the risk?
Risk, the uncertainty of injury or loss, plays an important part in everyday lives. The head of a household who purchases a life insurance policy to protect his or her family against economic loss due to death is concerned with risk. So is the family who buys a homeowners policy to provide for replacement funds in case of fire, flood or other damages; a motor vehicle liability policy to pay the medical and repair bills in the event of a car accident; and a health insurance policy to pay for any expensive medical care that family members may need.
All of the above risks have two key elements in common: (1) the possibility of loss and (2) uncertainty about when a loss will occur.
Two major types of risk occur:
Speculative risk the possibility exists for gains as well as losses. The person, who makes decisions about markets, products to offer and prices to charge, faces the possibility of rewards for wise decisions and for losses should the decisions prove wrong.
Pure risk the threat of loss exists without the possibility of gain. If a person’s car is damaged in an accident, there is no legitimate possibility of gain, yet the car must be replaced. If a young patient dies, he or she will leave a spouse and children without his or her income-producing abilities and with no legitimate possibility of gain. Pure risk is the only kind of risk with which insurance is concerned.
Because risk is part of life, we must find ways of dealing with it.
Five basic methods exist to manage risk: