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What is Pure Risk? (And what do I do about it?)
 
By Kyle Hatchett

Last week, we talked about how there are two kinds of risks, and that one kind is insurable, while the other is not. Speculative risk, a risk in which there could be either a gain or a loss, is not insurable, because the possibility of gain entices people to take on more risks. But in many risky situations, there is no possibility of gain, only loss. When there is a possibility of loss with no possibility of gain, that is called pure risk. And pure risk is everywhere. Let me give you a few examples:

Driving

Like it or not, every time you get in your car and drive, you risk the possibility of loss to your vehicle in an accident, and also the possibility of causing a loss to someone else, which, because of the principle of liability, will cause a financial loss to you too. Thus, you risk the loss of the value of your vehicle and the loss of your assets. However, there is no possibility that driving will cause the value of your vehicle (or your net worth) to go up. It can only go down. Since there is only the possibility of loss, and not of gain, this is an example of pure risk.

Weather

  

The same holds true for your house. Heavy rain, hail, and wind can all hit (or make other stuff hit) your house. When that happens, your house will incur a loss, and that loss is measurable by the amount it would cost to repair the damages. No amount of wind and rain can make your house's value go up; only down, so this is another example of pure risk.

So, with pure risk, your options are either loss or no loss

The Good News

Pure risk sounds pretty terrible, doesn't it? But there's good news. Pure risk is insurable.

Why is Pure Risk Insurable?

Not Morally Hazardous
Remember the term moral hazard from last week? In insurance hazard is anything that increases risk. A moral hazard is a situation (or sometimes a way of thinking) that causes people not to take normal precautions, but instead to take on unnecessary risk. These come in many forms, and we'll talk more about them later, but the thing to understand now is that moral hazard reduces people's normal, natural fear of risk.
 
Generally people don't seek out pure risk the way they do with speculative risk. Think about how driving your car is different from buying a lottery ticket. When you buy a lottery ticket, you risk losing money, but the possibility (however remote) of gaining a larger amount of money makes that risk attractive.  Not so with pure risk! You do not gain much by driving unsafely. You gain even less by having bad weather hit your house. Insurers don't want to protect against risks people take on purpose, but since most people don't intentionally wreck their cars or damage their homes, homes and cars are easy to insure. They are pure risks, and not morally hazardous.

Measurable
A risk that can be measured can usually be insured against, and the financial consequences of most pure risks are measurable. Insurance companies gather data on how many homes are damaged from year to year, and what the average repair costs are. The same holds true for automobile losses, damages awarded by in law suits, and many other things. When insurers find out how much a loss costs and how likely it is to occur, they can often come up with a reasonable plan to insure against that kind of loss, along with a responsible amount of money to charge for it.

Conclusion
So yes, these pure risks are both very common and often very expensive, but the good news is that they are easy to transfer via insurance. That's what insurance is: risk transfer from you to the insurance company.

So, do you have any risks that you'd like to get off your shoulders. If they're pure risks, there's a good chance that they are insurable. Give us a call to find out. 931-967-7546
Posted 2:37 PM  View Comments

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