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Risk Financing - Meaning - Risk Management
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Risk Financing – Meaning

Risk Financing:

If risk cannot be controlled, it is prudent to ensure that in the event of a risk occurring there is a mechanism in place to make good the financial loss. There are two methods of risk financing.

Risk Retention

The first is risk retention -if the severity of financial loss is not high and where frequency of occurrence is high, it is better to retain risk. For instance, a company which provides medical benefits to its employees may decide not to opt for insurance for smaller sicknesses like coughs and colds. The company will itself bear the cost treatment for its employees. Risk retention involves accepting the loss, or benefit of gain, from a risk when it occurs. True self-insurance falls in this category. Risk retention is a viable strategy for small risks where the cost of insuring against the risk would be greater over time than the total losses sustained. All risks that are not avoided or transferred are retained by default. This includes risks that are so large or catastrophic that they either cannot be insured against or the premiums would be infeasible. War is an example since most property and risks are not insured against war, so the loss attributed by war is retained by the insured. Also any amount of potential loss (risk) over the amount insured is retained risk. This may also be acceptable if the chance of a very large loss is small or if the cost to insure for greater coverage amounts is so great it would hinder the goals of the organization to0 much.

The second method is risk transfer the same company will undertake insurance for those illnesses that cost a lot for treatment. In the event of an employee being infected by a major illness, the insurance company will reimburse the treatment amount. In this scenario, the company is transferring the financial risk to an insurance company. Ideal use of these strategies may not be possible. Some of them may involve trade-offs that are not acceptable to the organization or person making the risk management decisions.

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