Updated: February 24, 2023
KEY TAKEAWAYS
- Pure risk can’t be controlled and can only have two outcomes. These are either no loss at all or complete loss.
- There aren’t any opportunities for profit or gain when pure risk is involved.
- Pure risk can be broken up into three separate categories. They are property, personal, and liability.
- A large number of cases of pure risk are able to be insured against.
What Is Pure Risk?
Pure risk is a category of risk that has no controllable factors. It has two outcomes: no loss at all, or complete loss. When pure risk is involved, there are no opportunities to profit or achieve any gains.
Pure risk is most common in situations such as fires, natural disasters, or death. They are situations that cannot be predicted and are beyond control. It is also commonly known as absolute risk.
Types Of Pure Risk
There are three main types of pure risk. They are as follows:
- Personal pure risk
- Property pure risk
- Liability pure risk
Let’s take a closer look at these three main types in more detail.
Personal Pure Risk
Personal risk can directly affect an individual person and can involve a loss of earnings and assets. It can also involve an increase in expenses. So for example, let’s say somebody becomes unemployed. This can create financial burdens due to the lack of steady income and employment benefits. If somebody has their identity stolen then they could end up with a damaged credit score. Or if somebody becomes ill, they can end up with large medical bills as well as no steady income which can lead to debt.
Property Pure Risk
When it comes to property risks, a property may be damaged by uncontrollable forces and natural disasters. Such as fire, hurricanes, tornados, lightning, etc. The loss of property from theft can also fall under this category. You can incur both direct and indirect losses from property pure risk.
Liability Pure Risk
Liability risks can involve litigation. This is due to either perceived or real injustice. So for example, if a person is badly hurt after slipping on a store’s wet floor, they may sue the store owner. This would be for things such as medical expenses, loss of income, and any other damages associated with the accident.
All liability risks are considered to be pure risks.
Pure Risk vs Speculative Risk
Pure risk is risk that is beyond the control of anyone involved and it can only result in a loss if it occurs. Whereas speculative risk is risk that is voluntarily taken on. It can result in either a profit or a loss.
Therefore, speculative risks are considered controllable risks. For example, almost any financial investment is considered a speculative risk. This is because they are chosen and can result in loss or gain.
Things such as gambling also fall under the category of speculative risk. A person who bets on a horse winning a race can either see a financial loss or gain from the bet, and they can choose which horse to bet on. This gives the person control and therefore makes it speculative.
Pure risk is often handled by insurance, whereas speculative risk is commonly handled by the capital markets.
Pure Risk Insurance
Unlike speculative risk, pure risk is commonly insurable through personal, commercial, or liability insurance policies. An individual can transfer a section of a pure risk to an insurer or insurance company.
So for example, a homeowner might purchase home insurance. This would be to project themselves against a number of things that may cause damage or loss to the property. This risk is now shared between the homeowner and the insurer.
Pure risk is insurable due to the law of large numbers. This is a law in probability and statistics that states that as a sample size gets bigger, its mean gets closer to the average of the population. This law applies more readily to pure risk than it does to speculative risk. Because risk management professionals are more capable of predicting loss figures in advance, meaning they won’t extend into a market if they don’t see it as profitable.
Some people may choose to not get insurance for certain pure risks. This is because they believe that the small chance of a pure risk event happening to them means that the insurance is not worth the cost that the insurance premiums would charge. However, when these events do take place, they can result in total loss. So on the scale of things, the cost of insurance would tend to be cheaper than paying to recover from total loss.
Examples Of Pure Risk
Common examples of pure risk are:
- Untimely deaths
- Acts of terrorism
- Earthquakes
- Tornadoes
- Fires
- Floods
- Other natural disasters
Summary
Pure risk, or absolute risk, is an uncontrollable form of risk. It can only result in two things. It either results in no loss or complete loss. It differs from speculative risk in the sense that speculative risk can be controlled. As well as speculative risks, outcomes are either profit or loss.
Pure risk is important in business as it can be insured against in most cases. This means that a business can minimize the amount of loss that it takes on.
Pure Risk FAQs
Why Is Pure Risk Insurable?
Pure risk is insurable through liability, commercial, or personal liability insurance. They are insurable because of the likelihood of the event occurring. The majority of the insurance companies’ clients will never have to make a pure risk claim, which would outweigh the number that does.
How Do You Manage Pure Risk?
There are four main ways in which you can manage and mitigate pure risk. That is through reduction, avoidance, acceptance, and transference. The most commonly used way to manage pure risk is to share it with an insurance company. This can be done by purchasing an insurance policy.
What Is the Difference Between Business Risk and Pure Risk?
Business risk is the risk event of gain or loss that results from business activities. Pure risk is only a risk of loss, such as fire or theft.
