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Managing risk with insurance

Risk is defined as the uncertainty of an outcome—opportunity or threat—of actions and events. It is assessed as a combination of the likelihood of an eventuality, its impact, and the severity of damage caused.

Print Edition: January 8, 2009

TYPES OF RISKS AND THEIR IMPACT
Risk typeExamplesPossible consequences
Personal risks• Accident.
• A key person leaves.
• An entrepreneur is overburdened.
• Loss of work input.
• Company loses expertise.
• Ability to work is reduced.
Business risks• Demand for a product decreases.
• Disruption in customer’s payment.
• Production capacity doesn’t correspond to customer’s needs.
• The company’s finances suffer.
• The anticipated income doesn’t arrive.
• The customer changes supplier.
Property risks• Fire in a production facility or a shop.
• Water leakage damages the company’s stocks.
• A machine breaks down.
• Sizeable damage, business operation is interrupted for several months.
• Production and delivery are disturbed.
• Production is interrupted.
Risk is defined as the uncertainty of an outcome—opportunity or threat—of actions and events. It is assessed as a combination of the likelihood of an eventuality, its impact, and the severity of damage caused. For instance, there is the possibility of a car meeting with an accident for no fault of its own if another car hits it from behind because it fails to apply the brakes on time.

The terms risk, loss and insurance are interlinked and inter-dependent, posing a problem and offering a solution at the same time. Insurance is chiefly a risk management tool that offers protection in the event of a risk taking effect and causing harm. What this means is that you cover yourself against the risk and offset the damage with an insurance. For instance, most software professionals keep a back-up of important files in case of loss or damage to the original.

Risk is unavoidable and every organisation needs to take action to manage it. The amount of risk that it decides is justifiable to be covered is called ‘risk appetite’. For instance, if have a good driving record and an old car whose book value has decreased substantially, you have the choice to drop the ‘own damage coverage’ (where the damage is not inflicted by someone else). So if you meet with an accident, you will pay for the damages yourself. In this case, you decide to retain the risk rather than transfer it to an insurance company. Alternatively, you could retain only part of the risk and insure the rest.

This is called ‘internal control’ and may involve one or more of these: tolerating risk; treating risk to constrain it to an acceptable level or actively taking advantage; regarding uncertainty as an opportunity to gain benefit; transferring risk and terminating the activity leading to risk. All insurance, other than life, falls under general insurance and is based on three principles. (Read in the next issue).

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