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    risk can also be managed by ..................... transfers of risk.

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    Risk Transfer

    Risk transfer refers to a risk management technique in which risk is transferred to a third party. In other words, it involves one party assuming risk

    Risk Transfer

    A risk management technique involving the transfer of risk to a third party

    Written by CFI Team

    Updated December 5, 2022

    What is Risk Transfer?

    Risk transfer refers to a risk management technique in which risk is transferred to a third party. In other words, risk transfer involves one party assuming the liabilities of another party. Purchasing insurance is a common example of transferring risk from an individual or entity to an insurance company.

    How It Works

    Risk transfer is a common risk management technique where the potential loss from an adverse outcome faced by an individual or entity is shifted to a third party. To compensate the third party for bearing the risk, the individual or entity will generally provide the third party with periodic payments.

    The most common example of risk transfer is insurance. When an individual or entity purchases insurance, they are insuring against financial risks. For example, an individual who purchases car insurance is acquiring financial protection against physical damage or bodily harm that can result from traffic incidents.

    As such, the individual is shifting the risk of having to incur significant financial losses from a traffic incident to an insurance company. In exchange for bearing such risks, the insurance company will typically require periodic payments from the individual.

    Methods of Risk Transfer

    There are two common methods of transferring risk:

    1. Insurance policy

    As outlined above, purchasing insurance is a common method of transferring risk. When an individual or entity is purchasing insurance, they are shifting financial risks to the insurance company. Insurance companies typically charge a fee – an insurance premium – for accepting such risks.

    2. Indemnification clause in contracts

    Contracts can also be used to help an individual or entity transfer risk. Contracts can include an indemnification clause – a clause that ensures potential losses will be compensated by the opposing party. In simplest terms, an indemnification clause is a clause in which the parties involved in the contract commit to compensating each other for any harm, liability, or loss arising out of the contract.

    For example, consider a client that signs a contract with an indemnification clause. The indemnification clause states that the contract writer will indemnify the client against copyright claims. As such, if the client receives a copyright claim, the contract writer would (1) be obliged to cover the costs related to defending against the copyright claim, and (2) be responsible for copyright claim damages if the client is found liable for copyright infringement.

    Risk Transfer by Insurance Companies

    Although risk is commonly transferred from individuals and entities to insurance companies, the insurers are also able to transfer risk. This is done through an insurance policy with reinsurance companies. Reinsurance companies are companies that provide insurance to insurance firms.

    Similar to how individuals or entities purchase insurance from insurance companies, insurance companies can shift risk by purchasing insurance from reinsurance companies. In exchange for taking on this risk, reinsurance companies charge the insurance companies an insurance premium.

    Risk Transfer vs. Risk Shifting

    Risk transfer is commonly confused with risk shifting. To reiterate, risk transfer is passing on (“transferring”) risk to a third party. On the other hand, risk shifting involves changing (“shifting”) the distribution of risky outcomes rather than passing on the risk to a third party.

    For example, an insurance policy is a method of risk transfer. Purchasing derivative contracts is a method of risk shifting.

    Additional Resources

    CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep learning and advancing your career, the additional CFI resources below will be useful:

    Actuary

    Commercial Insurance Broker

    Safe Harbor Subrogation

    See all risk management resources

    स्रोत : corporatefinanceinstitute.com

    Transfer of Risk Definition and Meaning in Insurance

    The transfer of risk is the primary tenet of the insurance business, in which one party pays another to bear the costs of some potential expenses.

    CORPORATE FINANCE CORPORATE INSURANCE

    Transfer of Risk Definition and Meaning in Insurance

    By JULIA KAGAN Updated December 14, 2020

    Reviewed by EBONY HOWARD

    Investopedia / Joules Garcia

    What Is Transfer of Risk?

    A transfer of risk is a business agreement in which one party pays another to take responsibility for mitigating specific losses that may or may not occur. This is the underlying tenet of the insurance industry.

    Risks may be transferred between individuals, from individuals to insurance companies, or from insurers to reinsurers. When homeowners purchase property insurance, they are paying an insurance company to assume various specific risks associated with homeownership.

    Understanding Transfer of Risk

    When purchasing insurance, the insurer agrees to indemnify, or compensate, the policyholder up to a certain amount for a specified loss or losses in exchange for payment.

    KEY TAKEAWAYS

    A transfer of risk shifts responsibility for losses from one party to another in return for payment.

    The basic business model of the insurance industry is the acceptance and management of risk.

    This system works because some risks are beyond the resources of most individuals and businesses.

    Insurance companies collect premiums from thousands or millions of customers every year. That provides a pool of cash that is available to cover the costs of damage or destruction to the properties of some small percentage of its customers. The premiums also cover administrative and operating expenses, and provide the company's profits.

    Life insurance works the same way. Insurers rely on actuarial statistics and other information to project the number of death claims it can expect to pay out per year. Because this number is relatively small, the company sets its premiums at a level that will exceed those death benefits.

    Reinsurance companies accept transfers of risk from insurance companies.

    The insurance industry exists because few individuals or companies have the financial resources necessary to bear the risks of the loss on their own. So, they transfer the risks.

    Risk Transfer to Reinsurance Companies

    Some risks are too big for insurance companies to bear alone. That's where reinsurance comes in.

    When insurance companies don't want to assume too much risk, they transfer the excess risk to reinsurance companies. For example, an insurance company may routinely write policies that limit its maximum liability to $10 million. But it may take on policies that require higher maximum amounts and then transfer the remainder of the risk in excess of $10 million to a reinsurer. This subcontract comes into play only if a major loss occurs.

    Property Insurance Risk Transfer

    Purchasing a home is the most significant expense most individuals make. To protect their investment, most homeowners buy homeowners insurance. With homeowners insurance, some of the risks associated with homeownership are transferred from the homeowner to the insurer.

    Insurance companies typically assess their own business risks in order to determine whether a customer is acceptable, and at what premium. Underwriting insurance for a customer with a poor credit profile and several dogs is riskier than insuring someone with a perfect credit profile and no pets. The policy for the first applicant will command a higher premium because of the higher risk being transferred from the applicant to the insurer.

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    स्रोत : www.investopedia.com

    Risk transfer (Definition, Types, Example)

    Guide to What risk transfer is & its Definition. Here we discuss the types of risk transfer, how they work, and their importance, such as advantages and disadvantages.

    What is Risk Transfer?

    Risk transfer can be defined as a mechanism of risk management that involves the transfer of future risks from one person to another, and one of the most common examples of risk management is purchasing insurance where the risk of an individual or a company is transferred to a third party (insurance company).

    Risk transfer, in its true essence, is the transfer of the implications of risks from one party (individual or an organization) to another (third party or an insurance company). Such risks may or may not necessarily take place in the future. Transfer of wagers can be executed through buying an insurance policy, contractual agreements, etc.

    Table of contents

    What is Risk Transfer?

    How does Risk Transfer Work?

    Risk Transfer Example

    Types #1 – Insurance #2 – Derivatives

    #3 – Contracts with an Indemnification Clause

    #4 – Outsourcing Importance

    Different Ways to Transfer Risk

    #1 – Certificate of Insurance

    #2 – Hold-Harmless Clause

    Advantages Disadvantages

    Recommended Articles

    How does Risk Transfer Work?

    One of the most common areas where risk transfer takes place is in the case of insurance. An insurance policy can be defined as a voluntary arrangement between the individual or an organization (policyholder) and an insurance company. A policyholder gets insured against potential financial risks by purchasing an insurance policy from the insurance company.

    The policyholder will need to make regular and periodic payments to the insurance company to ensure that their insurance policy is not getting lapsed because of the failure to make timely payments, i.e., premiums. A policyholder might choose from various insurance policies offered by various companies.

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    Risk Transfer Example

    A buys car insurance for $5,000, which is valid only for the physical damage of the same, and this insurance is right up to 31st December 2019. A had a car accident on 20th November 2019. His car suffers from severe physical damage, and the repair cost of the same accounts for $5,050. A can claim a maximum of $5,000 from his insurance provider, and he will solely bear the rest cost.

    Types

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    #1 – Insurance

    In an insurance mechanism, an individual or company can purchase an insurance policy from the preferred insurance company and safeguard itself from the implications of financial risks in the future.

    The policyholder will need to make timely payments or premiums to ensure that the undertaken insurance policy remains valid and does not fail because of failure to make timely payments.

    #2 – Derivatives

    It can be defined as a financial product that attains its value from a financial asset or an interest rate. Firms mostly buy derivatives to protect against financial risks like the currency exchange rate, etc.

    #3 – Contracts with an Indemnification Clause

    Individuals or organizations also use contracts with indemnification clauses for risk transfers. Contracts with such a clause ensure the transfer of financial risks from the indemnitee to the Indemnitor. In such an arrangement, the future economic losses shall be borne by the Indemnitor.

    #4 – Outsourcing

    Outsourcing is a type of risk transfer in which a process or project is outsourced to transfer various risks from one party to another.

    Importance

    This can be defined as a strategy for ensuring that a financial asset is safeguarded against future contingencies. It helps allocate risk equitably, i.e., it places the responsibilities for financial risks on the third party (insurance company in the case of an insurance and indemnitor in the case of a contract) who has taken the in-charge to safeguard the policyholder or indemnitee against future contingencies.

    This means that in the occurrence of an unfortunate event, the policyholder or indemnitee can be assured that the losses arising from the consequences of such an event will be duly taken care of by the insurance company or the Indemnitor.

    Different Ways to Transfer Risk

    #1 – Certificate of Insurance

    A certificate of insurance is used to minimize the financial liability of an individual or an organization. A certificate of insurance is made between the policyholder and an insurance company or insurance provider.

    This certificate must reflect the necessary information like the date of issue of the certificate, name of the insurance provider, policy name, policy numbers, date of commencement as well as the expiry of the insurance policy, name, address, and such other details of the insurance agent, amount of eligible coverage for each type of financial risk, etc.

    #2 – Hold-Harmless Clause

    These are contracts with indemnity clauses between an Indemnitor and an indemnitee. This agreement must reflect critical information such as the responsibility of the Indemnitor against any loss, damage, or future contingencies towards the indemnitee, etc. It is also known as a save-harmless clause.

    Advantages

    Safeguard Against Future Contingencies – It shields an individual or an organization against unforeseen financial risks that could be in the form of damage, theft, losses, etc. A policyholder or an indemnitee can always be assured that the insurance provider or the Indemnitor will bear the contingencies ahead in the future due to the transfer of risk through an insurance policy or hold-harmless agreement.

    स्रोत : www.wallstreetmojo.com

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