Pure Risk Explained: 4 Examples of Pure Risk

In the world of risk management, pure risk describes a scenario in which any type of change results in a physical or financial loss. This differentiates it from speculative risk, where there is a chance of loss but also a possibility of gain, depending upon particular outcomes.

To conceptualize pure risk, think, for instance, of the insurance market. When you purchase an insurance policy, both you and the insurance company hope that nothing will happen to your insured property. If anything does happen to trigger an insurance claim, that will mean something bad happened to your property. The insurance company will lose money paying out the claim and you will lose money, too, since most insurance payouts don’t cover the total amount of loss. There is no circumstance in which insurance coverage pays out because something good happened. They only pay when bad things happen. This explains why pure risk (also called absolute risk) is an intrinsic part of the insurance market.

Examples of pure risk exist in any scenario where the only possible outcomes are a neutral outcome where nothing changes or a negative outcome where things change for the worse. Pure risk applies to the following circumstances:

1. 1. Life insurance: When you take out a life insurance policy, two things can happen. You can either remain alive and the policy provides nothing. Or you can die—a very negative outcome—and the life insurance company may pay out to your heirs.
2. 2. Homeowners' insurance: Homeowners can protect themselves against certain insurable risks, all of which involve negative events. You’ll only receive payment from your homeowners' insurance if your home was damaged by a fire, a break-in, flooding, or a natural disaster resulting in property damage or destruction.
3. 3. Small business insurance: If you run a small business, you likely use this type of insurance to mitigate business risks. This may involve property risks, personal risk to employees, and potential losses from theft or lawsuits.
4. 4. Liability coverage: Liability insurance policies can be issued in the form of car insurance, event insurance, venue insurance, and more. These cover liability risks stemming from car accidents, fires, electrocution, and many other unsavory events. If you find your medical expenses are paid by someone’s liability insurance policy, that means something bad happened to you. That is because liability insurance covers pure risk scenarios. It never pays out for good outcomes.

Both pure risk and speculative risk involve potential neutral outcomes (where nothing changes) and potential negative outcomes (where something bad happens). Speculative risk adds a third scenario, a positive outcome where something good might happen.

Examples of speculative risk include investing in the stock market or gambling at a casino. In both cases, a person stands to risk some or all of their initial investment. However, good outcomes can also occur. The person might choose stock holdings that increase in value, or they might make money through their gambling. In these scenarios, the person entered a scenario with three possible outcomes. In pure risk (also called absolute risk), there are only two possible outcomes: no change or negative change.

To greater understand the concept of pure risk, consider these three types of pure risk a person might encounter. All involve a binary option of neutrality (no change) or negativity (a change for the worse):

1. 1. Property risk: Property risk includes damage from natural disasters, fires, burglary, and flooding.
2. 2. Personal risk: Examples of personal risk include bankruptcy, unemployment, arrest, and identity theft.
3. 3. Liability risk: Liability risk involves assuming responsibility for damage to another person’s body or property. Car accidents, injury to others, and damage of others’ property are examples of pure risk involving liability.

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