Assumption of Risk: Risk Management Concepts§
Assumption of Risk, often referred to as Self-Insurance or Retention, is a risk management technique where an individual or business assumes the responsibility for expected, non-catastrophic losses. In this context, the entity protects itself from catastrophic losses by purchasing specific insurance policies to cover those events.
Detailed Explanation§
Assumption of Risk involves two primary components:
- Self-Retained Risk: This refers to the expectation of bearing losses that are deemed manageable. For example, a company handling minor absenteeism due to employees’ short-term illnesses.
- Catastrophic Loss Coverage: This involves transferring substantial risks to insurance providers. For example, purchasing disability insurance to cover extended illness periods among employees.
Instances of Assumption of Risk§
- Voluntary Acceptance of Danger: Situations where an individual knowingly engages in risky activities (e.g., extreme sports) are considered an assumption of risk.
- Insurance Company Acceptance: When an insurance company agrees to underwrite a policy, they accept certain risks inherent to the policyholder’s coverage.
Examples§
- Business Scenario: A tech firm elects to manage minor IT equipment failures internally but buys cyber liability insurance to guard against major data breaches.
- Personal Scenario: An individual does not insure a cheap second-hand car but holds comprehensive insurance on a luxury vehicle.
Frequently Asked Questions (FAQs)§
Q1: Why might a company choose Assumption of Risk? A1: Companies may opt for Assumption of Risk to reduce premium costs for insurable risks that they deem manageable without insurance.
Q2: What are the benefits of Self-Insurance? A2: Self-Insurance provides control over risk management costs and processes, potentially leading to cost savings compared to traditional insurance.
Q3: Can businesses partially use Assumption of Risk? A3: Yes, businesses often use a hybrid model where they assume manageable risks and insure against larger, financially crippling risks.
Q4: What is the primary risk of Assumption of Risk? A4: The main risk is the potential underestimation of losses, which may strain resources if frequent or unexpectedly severe incidents occur.
Related Terms§
- Risk Retention: Opting to accept risk without transferring it to an insurance company.
- Loss Prevention: Measures taken to reduce the likelihood or impact of risk events.
- Premium: The payment made to an insurance company for coverage.
- Deductible: The amount the insured must pay out-of-pocket before insurance coverage kicks in.
Online References§
- Investopedia - Assumption of Risk
- Wikipedia - Risk Management
- International Risk Management Institute
Suggested Books for Further Studies§
- “Principles of Risk Management and Insurance” by George E. Rejda and Michael J. McNamara
- “Risk Management and Financial Institutions” by John C. Hull
- “Handbook of Risk Management in Energy Production and Trading” by Raimund M. Kovacevic
Fundamentals of Assumption of Risk: Insurance Basics Quiz§
Thank you for exploring the intricacies of risk management with Assumption of Risk and completing our knowledge quiz. Continue enhancing your expertise in financial and business practices!
