Methods that an insurance company uses to handle risk –
Risk management is a continuous process where management takes some measure to minimize the level of risk as well as the associated loss. It is the procedure of identifying, assessing, and controlling threats to an organization’s assets and earnings.
Though the various techniques of risk management will be discussed later on, the following discussion will give us a brief idea of how the risk is handled.
Avoidance: Avoid the risk or the circumstances which may lead to losses in another way, includes not performing an activity that could carry risk. Avoidance may seem the answer to all risks, but avoidance risks also mean losing out on the potential gain that accepting the risk may have allowed. Not entering a business to avoid the risk loss also avoids the possibility of earning the profits. Examples:
- Buying a property or business in order to not take on the liability that comes with it.
- Not flying in order to not take the risk that the airplane was to be hijacked.
- Not to visit border areas at the time of war tensions.
- Avoid manufacturing and marketing a product of which patent/copyright is doubtful.
Loss prevention: Reduce loss frequency, for example not to smoke in a factory producing inflammable products getting training before driving etc.
Loss reduction: Lower loss severity-development of firefighting equipment first aid boxes etc.
Retention: Retain, in full or part of the risk. A risk is said to be actively retained if the individual is fully aware of the risk and its implications and prefer to retain it. On the contrary, it is said to be passive, if the individual is ignorant of the risk or there is any carelessness on the part of the exposed.
Examples: War is an example since most .property and risks are not insured against war, so the loss attributed by war is retainable by the insured. Also, any amount of potential loss (Risk) over the amount insured is retained risk.
Transfer: Transfer means causing another party to accept the risk, typically to a contractual agreement or by corporatizing.
Contractual agreement: Insurance is one type of risk transfer that uses contracts. Other times it may involve contract language that transfers a risk to another party without the payment of an insurance premium. Liability among construction or other contracts is very often transferred this way. On the other hand, taking offsetting positions in derivatives is typically how firms use hedging to financially manage risk.
Corporatizing: Converting the sole proprietor partnership business into a company from an organization. It is well known that in case of a proprietor firm, the proprietorship is individually liable in an unlimited sense and in case of partnership firm, the partners are jointly and individually liable which is also in the nature of unlimited liability.