During our last installment, we introduced the three basic ways to mitigate risk: avoidance, retention and transference. Following is an example to help illustrate these techniques.
Let’s assume you are out driving in the country and come to a sign that says “Caution Minimum Maintenance Road. Level B Service. Enter at your own risk.” While the rest of this article could be spent listing and describing all of the possible risks to traveling down a “Level B Service” road, let’s take a look at it solely from the risk to the vehicle you are driving. If you drive down this road you may be risking as little as changes to your vehicle’s front-end alignment, to as great as a collision with a small tree on what used to be the shoulder of the poorly-maintained road.
Risk avoidance in this example would be simply to not travel down the road, but rather take an alternate (better maintained) route. Risk retention would be recognizing that you are risking the loss of a smooth ride due to your car falling out of alignment (those in the field of automotive repair could probably give other losses due to a car falling out of alignment) and you, personally, are willing to pay to correct this loss and get your vehicle’s front-end realigned. Colliding with the small tree could cause the loss of the use of your car.
You determined when you bought your vehicle that the cost of paying for these kinds of repairs or the need to replace your car is too great for you to pay out of your own pocket. Therefore, you decided to pay premiums every six months to an insurance company who is willing to cover the cost to repair or replace your car in events like the one described above occur. This is an example of risk transference. You are willing to pay a smaller amount of money periodically to someone else (an insurance company in this case) so that you avoid paying the considerably greater cost that may occur at an inopportune time for you financially (Murphy’s Law).
As mentioned earlier, risk exists all around us. As a responsible member of society though, it is important that we periodically take stock of these risks and determine if we can avoid them, cover them ourselves or need to transfer them to others. In future installments, we will take a closer look at some of the major risks that exist today and the basics that surround the risk transfer process (purchase of insurance).
Information provided by Dave LaGrange, CFP, Bridges Financial Associates Inc., 56 Court St., Winterset, 462-9500.