1.4.3 Treatment of Risk
There are four risk management techniques used to deter insurance risk levels.
- Risk Avoidance
- Risk Reduction
- Risk Retention
- Risk Transference
It is important to understand the differences.
Risk Avoidance
Risk avoidance occurs when individuals evade risk entirely. It is the act of not doing something that could possibly cause a loss or the inactivity of participation in an event that may potentially cause a loss situation. An example would be driving an automobile. If Lee doesn't drive, he avoids getting into an auto accident.
Risk Reduction
Risk reduction takes place when the chances of loss are lessened. Changing one's lifestyle to minimize a known risk is an example of risk reduction.
Lee starts thinking he just might want to drive someday, but there have been a few auto thefts in the neighborhood lately. So he wants to make sure he purchases a vehicle with an anti-theft device, thus reducing the chances of having his new car stolen.
Risk Retention
Risk retention is being aware of the risks involved and taking precautions for financial protection.
Lee decides he really wants to drive and accepts the fact that the possibility of an accident exists. Now he must decide what limits to put on his financial responsibility by choosing his deductible. The auto policy's deductible is an illustration of risk retention. Through the deductible, the insured retains part of the risk, the part that he is responsible for. One way to handle a retained risk is through self-insurance.
Risk Transference
Risk transference is the act of shifting the responsibility of risk to another in the form of an insurance contract.
Through the insurance contract, the burden of carrying the risk and indemnifying the financial loss is transferred from the individual to the insurance company.
Purchasing insurance does not eliminate risk entirely; however, it is one of the most effective ways of transferring risk.
Unfortunately, an unavoidable part of everyday life is risk. Merely crossing a street can put someone in danger.
Different people handle risk in different ways. Typically, past or personal experiences determine how an individual will respond to uncertainty. Before a person can determine the best way to handle a risk, that person must be able to identify risk probability and severity. What is the likelihood of suffering a loss, and how extensive might the resultant damage be?
This evaluation is referred to as risk management. Risk management is the process of:
- determining what exposures to loss exist;
- determining the seriousness of exposures; and
- developing a way of minimizing the effect of exposure.
The goal of risk management is to make the best possible arrangements ahead of time so that one will not be seriously affected financially when a loss occurs. Risk management is intended to protect income and assets against unforeseen, unintended, or accidental loss.
