What is 'Pure Risk'
Pure risk is a category of risk in which loss is the only possible outcome, which is the opposite of speculative risk. There are products that can be purchased to mitigate pure risk, such as home insurance being used to protect homeowners against their homes being destroyed. Other examples of pure risk events include premature death, identity theft and career-ending disabilities.
BREAKING DOWN 'Pure Risk'Society is harmed when pure risk is present and a loss occurs, such as an earthquake that kills hundreds of people.
Types of Pure Risk
Personal risks directly affect an individual and may involve losing or reducing income or assets, or gaining expenses. For example, unemployment may create financial issues when income and employment benefits are lost. Identity theft may result in damaged credit reports and a lower FICO score, increasing the cost of borrowing money. Poor health may result in large medical bills, loss of earned income and depletion of savings. Old age may result in insufficient income during retirement. Permanent disability may end a career and limit entry into other lines of work. Premature death may leave a household with unfulfilled financial obligations such as supporting dependents, paying a mortgage and educating children.
Property risks involve having property damaged or lost due to forces outside a person’s control. For example, fire, lightning, windstorms or hail may cause property damage.
Liability risks may involve litigation due to a real or perceived injustice. For example, a person slipping on ice in a neighbor's driveway and breaking a leg may sue the neighbor for medical expenses, lost income and other damages.
Unlike pure risk, speculative risk has the potential for earning a return or gain and requires considering all risk factors before choosing a course of action. For example, investors purchase securities believing they will increase in value. Businesses venture into new markets, purchase new equipment and diversify existing product lines because the potential gain is perceived as greater than the potential loss.
Insuring Against Pure Risk
Unlike most speculative risks, pure risks are typically insurable through commercial, personal or liability insurance policies. Individuals transfer part of a pure risk to an insurer. For example, homeowners purchase home insurance to protect against natural disasters and provide money for rebuilding.
Pure risks are insurable partly because the law of large numbers applies more easily to pure risk than speculative risk. Insurers are more capable of predicting loss figures in advance.