What is Pure Risk
Pure risk, also known as absolute risk, is a category of hazard in which the outcomes are a loss or no loss, and there is no opportunity for gain. Examples of pure risk situations include premature death, identity theft, and career-ending disabilities. There are products available to mitigate pure risk hazards, such as homeowners insurance, which helps protect homeowners against the destruction of their homes.
BREAKING DOWN Pure Risk
It is harmful when pure risk is present and loss occurs. As a contrast to pure risk, the outcomes of speculative risk include loss, gain, or no change. There are three types of pure risk: personal, property, and liability. There are four mitigation methods available to limit potential hazards. These methods are reduction, avoidance, acceptance, and transference. The most common method of dealing with pure risk is to transfer it to an insurance company by purchasing insurance.
Types of Pure Risk
Personal risks directly affect an individual and may involve the loss of earnings and assets or an increase in expenses. For example, unemployment may create financial burdens from the loss of income and employment benefits. Identity theft may result in damaged credit, and poor health may result in substantial medical bills, as well as loss of earning power and the depletion of savings.
Property risks involve property damaged due to uncontrollable forces, such as fire, lightning, hurricanes, tornados, or hail.
Liability risks may involve litigation due to a real or perceived injustice. For example, a person injured after slipping on an icy driveway of another person's property may sue for medical expenses, lost income, and other associated damages.
Unlike pure risk, speculative risk has the opportunities for loss or gain and requires considering all potential risks before choosing an action. As an example, investors purchase securities believing they will increase in value, however, the opportunity for loss is always present. Businesses venture into new markets, purchase new equipment, and diversify existing product lines because they recognize the potential gain surpasses 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 perils that cause damage or loss. The insurer now shares the potential risk with the homeowner.
Pure risks are insurable partly because the law of large numbers applies more readily than to speculative risk. Insurers are more capable of predicting loss figures in advance and will not extend themselves into a market if they see it as unprofitable.