¶ … Smith family reunion: Risk management

When debating if they should rend an indoor pavilion for their annual family reunion, the Smith family is engaged in some real-life risk management analysis. The family could 'bet' that the weather would be perfect, not rent the pavilion, and keep budgeted costs as low as possible. The potential gains from not renting the pavilion, if the weather is fine, are the savings of the rental cost. However, the weather is supposed to be cool or rainy. While weather predictions are often imperfect, if the event is rained out, with no indoor facility for protection, the prospective attendees will lose the time and money they spent preparing for the event, which is much greater than the cost of renting the indoor facility. A cost-benefit analysis suggests that the costs of not renting the pavilion and having the event rained out are much greater than the costs of renting the pavilion and having an indoor location prove unnecessary.

In this instance, renting the facility is hedging one's bets, or assuming that a worst-case scenario is possible, at least given the available information about the weather. Renting the pavilion becomes a kind of insurance strategy for the Smiths. In the case of most insurance policies, the worst-case scenario is not realized, even though the payer is poorer than if he or she assumed the 'best case' scenario and the catastrophic event did not occur. People pay for traveler's insurance, if there is likelihood of a trip being cancelled because of inclement weather or if they know there is a possibility they will not be able to attend. They also pay for house and car insurance, even though they hope nothing will happen to these valuable assets. But because the dangers of something going wrong are so great, insurance is seen as a necessity. The damage done to the parties involved is not as great as a flooded basement, if the reunion is rained out. But the relatively small fee of renting the facility, and the small savings gained if the risk of not having the outdoor facility is taken suggests that obtaining the indoor rental is a wise idea.