Methods of Risk Management

There are four methods to manage risk: Avoid Risk, Control Risk, Transfer Risk, or Retain Risk.

Avoiding risk. This may seem simplistic, but it certainly is the best way to deal wit risk. You don't cross the street against the light, you don't drive in a blizzard, you don't build your house on the river's edge, and you don't let your kids play with matches.

Controlled risk. This requires a bit more work. You must take measures to reduce the possibility of loss. If you do drive in a blizzard, you have a four wheel drive vehicle, four good snow tires, and air bags to protect you. Having smoke and heat detectors in your home to alert you of a fire and give your family enough time to get to safety is another example of controlling risk.

Transferring risk. This is what you do when you purchase insurance; you allow the insurance company to assume the financial liability of a loss that you cannot afford on your own. The loss of your home could financially devastate you, so you transfer that financial risk by paying the insurance company a fee (the premium) to assume the risk for you.

Retaining risk. This is accepting responsibility for some or all of the risk. Most common is the use of deductibles. By using deductibles, you agree to self-insure the small claims. Co-insurance and elimination periods are also ways to retain risk. There are instances in which we choose to self-insure. For example, if you have six months' worth of living expenses set aside, you may choose to purchase only long-term disability insurance because you have enough in assets to cover a short-term disability.

Insurance can be a complicated product to purchase because you are entering into a contract with an insurance company that only wants to pay out on a claim under certain circumstances. To properly protect yourself and all that you love, you need to learn to read the fine print of those contacts.