Assumption of Risk

A technique of risk management where an individual or business assumes expected losses that are not catastrophic, protecting against catastrophic losses through insurance.
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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:

  1. 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.
  2. 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

  1. Voluntary Acceptance of Danger: Situations where an individual knowingly engages in risky activities (e.g., extreme sports) are considered an assumption of risk.
  2. Insurance Company Acceptance: When an insurance company agrees to underwrite a policy, they accept certain risks inherent to the policyholder’s coverage.

Examples

  1. Business Scenario: A tech firm elects to manage minor IT equipment failures internally but buys cyber liability insurance to guard against major data breaches.
  2. 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.

  • 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

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

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