Risk Transfer Measures Soften Potential Losses
In the day-to-day flow of running your business, you're constantly made aware of the abundance of risks lurking behind every decision, maneuver and initiative. Unfortunately, those potholes that could result in losses aren't getting any smaller.
From climate-related incidents to cyberattacks, risks are multiplying in all corners of the business world. This makes operations, service, finance and forecasts increasingly tricky.
Many companies are bulking up their risk transfer functions to strike a more tolerable balance between unsustainable highs and devastating lows to help reduce the potential damage from such complications.
A natural occurrence
No decision comes without some element of risk. Therefore, relative to the decision's possible rewards, a company owner must decide whether to avoid risk or accept it as part of business.
For example, when deciding whether to expand into a new facility, an owner must weigh all of the pros and cons of acquiring or leasing an additional building. If they determine the risks aren't worth the investment a purchase requires, they may opt to lease a facility instead—although that comes with its own set of risks. If an owner determines the risks are too high in either case, the decision may be to stand pat.
Once you determine that a set of risks is worth taking, you face the choice of retaining them. If you do, you may be exposed to all the potential repercussions or reducing a portion through risk transfer.
What is risk transfer?
Risk transfer is the process by which you buffer your company from potential damages or losses by indemnifying it from potential liabilities.
Two primary approaches
The key to effectively transferring risk is finding an entity that's willing to shoulder some of it. This process primarily occurs through:
- Insurance: Your company pays a premium to an insurer that agrees to compensate the business if disaster hits.
- Contracts: Your company's agreements with customers, partners and suppliers include specific language around who's liable for what if disaster hits.
For example, many agribusiness companies rely on insurance to protect investments in property, equipment and structures. Coverage may also be used to guard against business interruptions resulting from natural disasters, or increasingly, cyber-related issues.
Within the healthcare industry, contractual risk transfer agreements are common, given the abundance of vendors and suppliers in and around facilities that pose numerous and varied risks. Ideally, the contracts clearly define expectations for responsibilities for all workers while balancing risks between the contractor and the facility.
Another approach that's more popular within the supply chain industry is captive insurance, which is when a company sets aside funds to self-insure its operations. This practice creates an entity that may or may not be owned by the company but provides a defined level of risk protection.
Constantly shifting sands
Risk is far from static, as the types and degrees of challenges your business faces are always evolving—especially as it grows and engages in new markets and with new suppliers.
Therefore, along with regularly gauging existing risks and assessing new risks as they arise, keeping your risk transfer measures aligned with your needs—and allowing for areas that may already be covered by your business insurance—is crucial.
Ultimately, risk is unavoidable, but by effectively mitigating it through risk transfer efforts, you'll help your business manage its potential impacts.
Financial insights for your business
This information is provided for educational purposes only and should not be relied on or interpreted as accounting, financial planning, investment, legal or tax advice. First Citizens Bank (or its affiliates) neither endorses nor guarantees this information, and encourages you to consult a professional for advice applicable to your specific situation.