Final answer:
To insure a pure risk, it must be due to chance, the risk must be estimable for premium calculations, and there must be significant financial harm potential. Insurance models require premium payments to cover claims, operational costs, and profit, while also managing imperfect information and moral hazard.
Step-by-step explanation:
Three Elements Required for Insuring Pure Risk
When considering the insurance of a pure risk, there are certain criteria that must be present before an insurance company can provide coverage. The three fundamental elements required for a pure risk to be insurable include:
- The risk should be due to chance, meaning it is unpredictable and not within the policyholder's control. This aligns with a fundamental aspect of insurance, which is to provide protection against unforeseen events.
- There must be the ability to estimate the risk accurately enough to calculate fair premiums that are reflective of the likelihood of the event occurring. While there is always imperfect information, actuarial science allows for the estimation of risks based on historical data and statistical modeling.
- The risk must have the potential to cause significant financial harm to the insured party, warranting the need for insurance coverage. This is because the essence of insurance is to alleviate severe financial burdens that may arise from adverse events.
It's important to understand that these elements are essential for the viability of insurance models. The average person's premiums must cover the average claims, the operational costs of the insurance company, and leave room for profits. Additionally, insurers must deal with imperfect information and moral hazard in developing insurance policies that are both actuarially fair and commercially sustainable.