Page 51 - DMGT515_PERSONAL_FINANCIAL_PLANNING

Personal Financial Planning

Notes 3.3 Pure Risk

A pure risk is one in which there are only the possibilities of loss or no loss (earthquake).
A category of risk in which loss is the only possible outcome; there is no beneficial result. Pure
risk is related to events that are beyond the risk-taker’s control and, therefore, a person cannot
consciously take on pure risk. This is the opposite of speculative risk.
For example, the possibility that a person’s house will be destroyed due to a natural disaster is
pure risk. In this example, it is unlikely that there would be any potential benefit to this risk.
There are products that can be purchased to mitigate pure risk. For example, home insurance can
be used to protect homeowners from the risk that their homes will be destroyed.
Other examples of pure risk events include premature death, identity theft and career-ending
disabilities.
Situation where there is a chance of either loss or no loss, but no chance of gain; for example either
a building will burn down or it won’t. Only pure risks are insurable because otherwise (where
the chance of the occurrence of a loss is determinable) insurance is akin to betting and the insured
may stand to gain from it—a situation contrary to the most fundamental concept of insurance.
Also called absolute risk.

3.3.1 Types of Pure Risks

Personal risks involve the possibility of a loss or reduction in income, extra expenses or
depletion of financial assets:

Premature death of family head
Insufficient income during retirement
Most workers are not saving enough for a comfortable retirement
Poor health (catastrophic medical bills and loss of earned income)

Involuntary unemployment
Property risks involve the possibility of losses associated with the destruction or theft of
property:

Physical damage to home and personal property from fire, tornado, vandalism, or
other causes
Direct loss vs. indirect loss:

A direct loss is a financial loss that results from the physical damage, destruction, or
theft of the property, such as fire damage to a restaurant
An indirect loss results indirectly from the occurrence of a direct physical damage or
theft loss, such as lost profits due to inability to operate after a fire
Liability risks involve the possibility of being held liable for bodily injury or property
damage to someone else:
There is no maximum upper limit with respect to the amount of the loss
A lien can be placed on your income and financial assets
Defence costs can be enormous

46 LOVELY PROFESSIONAL UNIVERSITY