Pure Risk (absolute risk) Definition
Pure risk, also called absolute risk, is a category of threat that is beyond human control and has only one possible outcome if it occurs: loss. Pure risk includes such incidents as natural disasters, fire or untimely death.
There are four basic ways of dealing with risk: reduce it, avoid it, accept it or transfer it. Pure risk is often transferred by purchasing insurance coverage, which transfers the risk to an insurance company.
Pure risk examples
Personal risks affect individuals and involve losing or reducing personal assets. For example, unemployment is a pure risk resulting in financial loss when income and benefits are taken away. There are numerous other types of personal, pure risks, however: Poor health runs the risk of large medical bills, and the risk of an unforeseen, permanent disability could end a person’s career and, as a result, dramatically reduce their income. The pure risk of premature death also impacts the deceased family members who might struggle to pay household bills if the breadwinner unexpectedly dies.
Pure risk to property includes fires, wind damage, flooding and other natural disasters that cause damage to personal belongings.
Liability risks are also considered pure risks and pertain to potential litigation against a person or organization. For example, a homeowner could be sued by a person who slipped on their walkway for medical expenses, lost income or other damages.
Pure vs. speculative risk
While pure risk is beyond human control and can only result in a loss if it occurs, speculative risk is taken on voluntarily and can result in either a profit or loss. Speculative risks are undertaken through a conscious choice, and they are considered a controllable risk. Almost all financial investment activities, for example, are considered speculative risk because they ultimately result in an unknown amount of success or failure.
Pure risk insurance
Pure risks are insurable through commercial, personal or liability insurance policies. In these polices, individuals or organizations transfer part of the pure risk to the insurer. For example, home insurance policies protect against natural disasters by providing money for rebuilding. For life insurance policies, the insured makes premium payments and the insurance company provides a lump-sum payment to beneficiaries upon the insured person’s death.
When a company provides insurance against a pure risk, they are engaging in speculative risk because the entity is trying to ensure that the customer will not experience a loss until the after the company has profited from the risk transfer.
Pure risks are insurable partly because of the law of large numbers makes insurers capable of predicting loss figures in advance.
