What is pure risk?
Pure risk is a type of risk that involves the possibility of loss or harm without any chance of gain or benefit. It's a situation where there are only two possible outcomes - either a loss will occur or nothing will happen. Examples of pure risk include natural disasters, accidents, and theft.
Pure risk is an important concept for anyone starting a business as it helps organizations identify and manage the risks that they may face. By understanding and preparing for potential losses related to pure risk, businesses can minimize their financial impact and safeguard their long-term success. Ignoring pure risk can lead to unforeseen consequences that can damage a company's reputation, bottom line, and even its existence.
The term "pure risk" has its roots in the insurance industry, where it is used to describe situations where there is only a possibility of loss or no loss at all. Over time, the concept of pure risk has evolved to encompass a broader range of risks faced by businesses, including natural disasters, accidents, and liability claims.
Key components of pure risk
In order to be considered pure risk, the following must apply:
In essence pure risk involves situations where there is only a possibility of loss or no loss at all. If the situation leads to a gain or benefit, pure risk doesn't apply.
It cannot be controlled or avoided entirely. You may be able to mitigate loss, by preparing for a predicted natural disaster, but not necessarily remove or stop it.
Pure risk is insurable generally. Exemptions or exceptions may apply.
It can have a significant impact on a business's financial health. A pure risk situation can render a budget plan obsolete, or deplete a businesses funds.
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Examples of pure risk situations
A few examples of pure risk include:
01. A fire at a manufacturing plant that damages essential equipment and the ability of a business to produce its product.
02. A natural disaster, such as a hurricane or earthquake that damages company offices, manufacturing capabilities or stops a business from operating.
03. A product liability claim against a company, due to a defect or fault, filed by an injured customer.
How to prepare for pure risk situations
Businesses, of any size, can prepare for potential pure risk situations by:
Identifying and assessing potential pure risks for your business. If you live in an area prone to hurricanes, for example, factoring this into your business plan is crucial.
Develop a risk management plan that outlines strategies for minimizing the impact of pure risks. This might include taking our insurance, or putting aside special funds.
Invest in insurance policies that cover potential losses related to pure risks.
Regularly review and update your risk management plan to ensure it remains effective. Potential risks may change and evolve as your business grows.
One of the main challenges associated with pure risk is that it is often unpredictable and uncontrollable. Therefore, businesses must be prepared to handle any potential losses that may arise. Additionally, some companies may struggle to find affordable insurance policies that cover specific types of pure risks and then they make need to plan their own protection against pure risk.
Why it's important to prepare for pure risk
Accounting for pure risk and preparing for it, either with insurance or rainy day funds to cover potential losses can make a business better prepared. It can also reduce the financial impact of a natural disaster or other loss situation. Preparing for risky situations can also calm down potential investors and mean greater trust in a business.