What Does Pure Risk Mean?
Pure risk refers to an unavoidable and uncontrollable event where the outcome eventually leads to either total loss or no loss at all. Examples include natural disasters, theft, property damage or death. Damage or loss brought about by pure risk events can be covered by an insurance policy.
With pure risk, there is no opportunity to gain or profit from the event. Pure risk is the opposite of speculative risk, which poses the opportunity to either gain or lose. Examples include investing in the stock market or gambling. One cannot insure against a speculative risk, as the purpose of insurance is to get one back to the same financial position as before the event, rather than to better their financial position.
There is no gambling with pure risk; it will happen eventually. An obvious example is the death of a person. Since mortality always happens, a person gets insurance to get a death benefit that will give financial security to their survivors. An example in commercial insurance is business interruption. For one reason or another, a business may need to close for a while (floods, fires, accidents, pandemics) and business interruption insurance will help provide financial security during that time.
Pure risk is also known as absolute risk.
Insuranceopedia Explains Pure Risk
To protect against pure risk events that could cause potential loss of property or financial security, the following techniques are used:
With risk reduction, the chances of the event happening are reduced by performing mitigation efforts. This includes locking the doors on a car, getting medical care, or purchasing a sump pump for a home to protect against flooding.
With risk avoidance, the chances of the loss happening are avoided altogether — someone’s car cannot be stolen if they have no car in the first place. Risk avoidance is more effective for speculative risks like purchasing stocks.
With risk acceptance, one accepts that the event may happen and does nothing about it. For example, not purchasing insurance would be a form of risk acceptance: One accepts the financial burden themselves if something happens to their property.
The most common form of risk mitigation is risk transference. This involves transferring the financial risk onto another party, like an insurance company.
A common pure risk auto insurance is theft — if the vehicle is stolen, the insurance company takes a loss, as they pay out to replace the vehicle. If the vehicle turns up undamaged, the insurance company does not take a loss at all. Most insurance contracts cite a 72-hour waiting period before the insurance company will consider paying out for a stolen vehicle, as vehicles are often returned or found (damaged or otherwise) within that time. No loss is better than a total loss, so they wait it out in the hopes the vehicle will turn up.
All liability risks are considered pure risks — a person might get sued and suffer from a financial loss, or may not be sued at all. For example, if someone slips and falls on a slippery walkway, they can either choose to sue the property owner or not. Insurance companies include liability coverage in almost all comprehensive auto and property coverages and will act as the owner’s representative after a loss has occurred — this is a form of risk transference as well.
Some people may choose to forego insurance because they believe the chances of the pure risk events happening to them are low or they simply may not want to pay the insurance premiums. However, when these events do happen, they can result in total loss. Insurance premiums come at a cost, but having to pay to rebuild an entire house after a pure risk event (plus the mortgage) can easily bankrupt someone.