As you begin to develop your financial plan, and more specifically your risk management strategy, there are a few ways that you can manage everyday risks. Some risk management techniques are mandated by laws, such as car insurance. However, not all risks and hazards are as regulated or as obvious as automobile accidents.
When evaluating the risks to your financial security, you will have to make the decision on how you will manage them. There are three common techniques to manage risk, avoidance, transfer and retention.
When posed with the opportunity to engage in an activity that creates an exposure to a loss (either financial, health or property), risk avoidance will eliminate any probability of loss from the event.
Choosing to completely avoid a risk is only possible for a few hazards of everyday life. Choosing not to build a pool in your backyard will help avoid the risk of drowning. However, we cannot completely avoid the risk of weather damage to our property as we have very little control over it.
An extremely common risk management technique is risk transfer. Transferring risk from one party to another helps reduce any potential liability or other financial damages when engaging in an activity that exposes you to a loss.
There are two types of risk transfer, insurance and non-insurance. Risk transfers through insurance is also referred to as one of the methods of financing risk. Through insurance you pay a fee, usually monthly, in-order to transfer the financial risk of large losses to insurance companies.
Non-insurance transfers can also occur through legally binding contracts, such as insurance. However you can also decide to transfer risk to another party through the use of services and subcontracting. The use of third parties through contracts will place the financial liability of damages on them, alleviating you of the risk and any sub-sequential loss.
The last of the common risk management techniques is the retention of risk. This method is in direct contrast to risk avoidance. When you decide to retain risk you are inherently financing the risk yourself. All losses incurred through hazards will be paid by you.
Companies that have a sufficient capital reserves may choose to retain some risks rather than purchasing insurance to cover any potential losses. In addition many consumers choose to retain some risk through the use of a high deductible.
Protecting your financial future begins with financial planning and proper risk management. These risk management techniques, should help you protect against large financial losses.