Insurance is only one of four methods to manage risk. The others are retention, avoidance, transfer and reduction.
So what exactly are these 4 methods to manage your risk and what are they good for?
4 methods of risk management
- Retention is retaining the exposure yourself. Ninety percent of Americans don’t have disability insurance. So they are “self insuring” or retaining the financial loss should they become disabled.
- Avoidance is the removal of the potential exposure or Hazard. An example is homeowner liability claims from dog bites. If you don’t want to be sued from your dog biting someone, then manage the dog to avoid the risk – like a high quality fence and keeping your dog inside when possible.
- To transfer the potential financial loss uses Insurance. You should only transfer those exposures you could not afford to a loss such a disability, death, a home or auto liability claims.
- Reduction is the process to reduce the likelihood of a claim. A homeowner can install a fire sprinkler system, smoke detection system and fire extinguisher in their home to reduce the probability of a fire loss or reduce the overall claim.
Now, insurance must meet several criteria.
They are:
– The law of large numbers must apply,
– The risk must be measurable in terms of financial loss,
– The loss must create a financial hardship,
– And the loss must not be catastrophic.
Insurance companies use statistical analysis and mathematical modeling to measure the probability of you having a loss. The factors used are changing quickly with technology. Smart chips and GPS tracking are two examples of technology based probability measuring.
Floods, earthquake, nuclear exposure, acts of war are catastrophic. These exposures are excluded from most insurance policies. The potential exposures would exceed the company financial capacity to pay losses.
To properly manage your risk, I would advising using a little of each of these four methods. For more information contact Paula Smith Insurance at (281) 488-8880 to get a complete review of your risk management to best protect your assets.