Pure risk represents a unique category of risk with two potential outcomes: total loss or no loss at all. Unlike other forms of risk, pure risk offers no opportunity for profit or gain – only the possibility of detrimental outcomes.
Pure risk often manifests in scenarios such as natural disasters, fires, or even death. Faced with its uncontrollable nature, it is also known as absolute risk.
Key Takeaways
- Pure risk can’t be controlled and presents two possible outcomes: complete loss or no loss at all.
- Opportunities for profit are non-existent when dealing with pure risk.
- There are three core types of pure risk: personal, property, and liability.
- Many pure risks are insurable, offering a pathway for mitigation through commercial or personal insurance policies.
Delving Into Pure Risk
Pure risk brings no measurable benefits; only two distinct possibilities exist: either no incident occurs, or a significant loss takes place. To effectively manage pure risk, one can consider four primary strategies: risk reduction, avoidance, acceptance, and transference.
The most common strategy is transference, accomplished by purchasing an insurance policy, thereby moving the risk to the insurer. For instance, insuring a vehicle against theft transfers the risk to the insurance company. If theft occurs, the insurer handles the financial loss. If it does not occur, there is neither gain nor loss for the insurer.
Pure risk contrasts sharply with speculative risk, where potential outcomes include gains or losses, and investors deliberately engage with it. Pure risks are more predictable and therefore insurable.
Classifications of Pure Risk
Personal Risks
Personal risks impact individuals directly, leading to loss of income, assets, or increased personal expenses. Examples include unemployment, which curtails income and benefits, identity theft causing credit damage, or poor health leading to high medical expenses and depleted savings.
Property Risks
Property risks involve the potential for damage from uncontrollable events such as fires, hurricanes, lightning, tornados, and hailstorms.
Liability Risks
Liability risks entail the legal and financial ramifications stemming from real or perceived oversights. For example, someone might sue for medical expenses and damages after slipping on an icy driveway.
Insuring Pure Risk
Unlike speculative risks, pure risks are more predictably insurable through various insurance policies, including commercial, personal, and liability insurance. By purchasing coverage, individuals can transfer a significant portion of the risk to their insurer. For instance, homeowners get insurance to safeguard against damage or loss.
Insurability of pure risks is feasible due to the law of large numbers, which aids insurers in accurately predicting losses and makes market engagement viable only when profitability is assured.
Speculative Risk
In contrast to pure risk, speculative risk encompasses both potential gains and losses. This type of risk is encountered when making conscious decisions to invest. For instance, investors acquire securities in hopes of value appreciation, yet face the ongoing possibility of loss. Similarly, businesses venture into new markets, upgrade equipment, or diversify product lines, balancing the potential gains against possible losses.
Related Terms: speculative risk, risk, insurance, natural disasters, liability insurance.
