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Risk and Insurance

The first nine months of your life were perfect. Floating all day in your personal indoor pool. Food service available 24/7. No underwear to change. You thought the good life would go on forever.

But then it happened. Eviction day.

Shoved out into the real world. The easy life was gone. Now you faced problems and threats to your security.

But as you grew up, your parents gave you advice to help keep you safe. "Look both ways before crossing the street". "Don't talk to strangers". And if you lived in Las Vegas, "Don't draw to an inside straight."

You didn't know it at the time, but your parents were giving you some rules for risk management. Where there's uncertainty, there's risk. And their advice was designed to protect you from harm by either avoiding dangerous situations or taking certain precautions.

How Risk Management Deals with Risk

Risk management is a way to reduce the financial risks a business or an individual faces. Part of a risk management plan involves insurance. But insurance is not the only way, and often not the best way, to handle risk. In fact, there are four ways you can deal with risks:

What are Your Risks?

Since you're no longer a child, it's up to you to see the risks you face and decide who and what you want to protect. The three areas of risk you want to consider are:

When You Do and Don't Need Insurance

Although your parents gave you basic risk management tips, unless they were actuaries (insurance math geeks), they probably didn't explain how a risk decision is made. This diagram shows what action to take depending on how often a risk occurs and its severity.
  How Often Risk Occurs
    Frequent Seldom
Large Avoid or
Reduce the Risk
Transfer the Risk
Small Reduce or
Assume the Risk
Assume the Risk

As the table shows, choosing insurance (Transfer the Risk) makes sense only if the risk seldom happens and has a high potential loss. If the occurrence is frequent, insuring against the risk would be too expensive. Likewise if the financial cost for a risk occurrence is small, look for non-insurance solutions.

Whenever you consider buying insurance, ask yourself what are the likely losses and could you handle the financial results if they occurred The easiest way to save money on insurance is to avoid it when there are better alternatives. So for every risk you look at, first think of ways to either avoid or reduce it's impact without insurance.

Types of Insurance

Insurance has two major categories of protection:

In addition to insuring people and property, specialty types of insurance cover such things as pet health care, travel-related mishaps, and even marriage ceremony problems.

What to Consider Before Buying Insurance

You can read more about understanding risk and risk management or creating your own personal risk management plan.