Insurance & Risk Management

Running Head: Insurance and Risk Management
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INSURANCE AND RISK MANAGEMENT
Introduction
A sense of security in terms of finances is as essential to any business just as food, clothing and shelter is to people. A business that has economic and financial security is certain that it would be able to meet most of its expenses for smooth operation as well as meets cost that may come as result of risks during operations. However, no matter how confident a company may be it terms of its financial capability, it is impossible to have the surety of meeting all accidents costs. This is because a business is exposed to many forms of risks in its course of operation. The only sure way of gaining that confidence and the longevity of a business is through acquiring an insurance policy.
Present society provides many examples of risks to a business. When the frequency and the intensity of disasters are on the rise, the ability of a business to bring down its vulnerability to the risks gets limited. When such disasters strike a business has to look for an external source of finance to mitigate the effects. This idea of sourcing for funds to mitigate the effect of costs incurred as result of a disaster is what calls for risk financing for a company.
RISK FINACNING
Risk financing basically attempts to mitigate two types of cost i.e. the costs due to losses and costs due to uncertainty. It attempts to alleviate the impact of these costs by structuring the availability of funds to pay claims, aid recovery and enable an organization to maintain financial stability as it moves forward. This can be achieved in various ways by the business. First there is the fully self-insured entity in which a business retains the responsibility and if risks related costs occur, the entity bears the entire cost directly. The other alternative is a fully insured business which directly transfers responsibility from bearing the risk to an insurance company hence trading regular losses to avoid potential of large and irregular losses.
Risk retention and sharing
For self insured-entities the costs of risks is financed through a combination of retention and sharing among a number of such business in an entity. Losses within stated sub limits or above the overall limits of coverage are retained by entity (NJK 2002 ). They share the timing risks associated with a loss. These conventional risks transfer or sharing programs provide for a smooth effect that protects a business from risk of not having sufficient funds on hand at time of loss.
The degree with which risk retention is attractive to a business entity is related to the control that the government can exert over the risk; the level of predictability associated with the risk; and the entity financial capacity to both bear the risk and to withstand variations (NJK, 2002). Before opting for either risk retention and sharing or risk transfer as a method for risk financing a business must put the following into consideration.
First the business must assess the cost of financing options available at its convenience. This is because the pool contribution is always based on the estimates of average losses to be paid out, the cost of adjusting the settling claims that give rise to those losses, as well as other operating costs (Gollier, 2007). In this way the business would be protected in the pool by smoothing the impact of large losses. An individual`s entity`s contribution reflects its shares` of the entire group`s loss experience. It may or may not track closely with its expectations.
Secondly, the business should consider the quality and value of services offered. In addition to claim handling, the risk financing scheme should have other services of risk management aimed at helping members prevent or minimize losses.
The last consideration is the opportunity cost of capital. The business should opt for a type of pool in which long term investment of funds earns higher rates of return. The proceeds are then retained and benefit the members by reducing the amount needed to be collected as contributions.
Risk transferring and the insurance
Risk transferring on the other hand involves a business entity acquiring insurance from another company. It is important for a business to acquire a commercial insurance even before its inception. When one starts a business or is operating one, many things may go wrong. For a starter, they may still be unaware of the business dealings as well as having employees that are new. Such a combination makes potential for mistakes very high. If one is lucky, the mistakes they make while the business is still at its inception stage may not always be much but more often than not, such mistakes lead to lawsuits ( Gollier, 2007 ).
If a business doesn`t have ac commercial insurance, it may end up losing everything should it be sued including even personal assets unless the business is set up correctly. It is evident that a business has so much liability hence ought to acquire a commercial insurance. On top of this the insurance sought should be an adequate commercial insurance. Just going for any insurance is not enough. A business need to make sure that there is enough insurance that would typically cover the type of claim that the business might encounter.
WHY INSURANCE IS AN IMPORTANT METHOD OF RISK FINANCING
Reduction of uncertainties and chances of loss
According to National Association of Insurance Brokers, any insurance is a sure way through a business removes uncertainties (1986). The insurance companies take the risks of large but uncertain losses with exchange of the small premiums paid by the business. This gives a sense of security which is a gift to a business. When all uncertainties are removed from a business income becomes almost certain and profits extend.
In addition, insurance companies spend a lot of money in trying to find out possible causes of accidents like fire hence educating the business on how to minimize such occurrences. They also find more information on theft, accidents and other risk causes to minimize their chances. They may ay also support several medical programs in order to make the public aware of safety. Such loss preventive activities of insurance companies reduce loss chances by great percentage.
Stimulating of a business enterprise
Insurance can maintain the large size commercial and industrial organizations. In the modern world, large business can rarely thrive without transferring some of their risks to an insurer. This helps safeguard the capital and at the same avoid the necessity on the par to the industrialists. They can go ahead and use their capital as they will.
Insurance as a credit source
Credits are important in the modern business and insurance has contributed a lot in the area. Insurance policies increase credit worthiness of the insured business because it can provide funds for repayment if any default occurs (Nilum, 2011). Property insurance also provides credit extensions of various kinds. Business people who have their stock insured can obtain credit easily. Indeed a marine insurance is an essential requirement for every transaction of import and export.
Correct cost distribution
All business people would try to pass on to the consumer all types of costs from accidents and all losses incurred. In the several areas of insurance, the losses are correctly estimated keeping in view a wide number of factors bearing on them (Arthur, 2007). If the insurance is not available, such costs would only be determined and distributed only by speculation.
Insurance as an investment
An insurance policy is a combination of protections and investments which are very useful. The premiums paid always accumulate every year. The money accumulated by the insurance also earns interest. In this way insurance can be regarded as an investment. Furthermore insurance also promotes saving. Saving helps immensely in preparing for the bad consequences of the future. Insurance policy is suitable for providing for the future. It promotes savings by making it compulsory which then is beneficial for business and individual.
Solving social problems
Insurance help serve for solving intricate social problems. This may include compensation for victims of industrial injuries and accidents caused to the people. It then enables the business units to continue intact even after a loss. According to Arthur, at the same time, insurance helps remove fear from the minds of individuals and the business (2007). An insured business is secured in the knowledge that the protection of the insurance fund is behind him if some sad event happens. This helps create confidence and also eliminates worries which boosts productivity.
Allocation of production factors and increased competition
Since insurance gives security many people would be willing to invest capital in such businesses. T his occurs if there is sure protection for the funds the investors are willing to put in the business. On top of all these, insurance helps the business to grow its competitiveness. It enables small business to compete equally with bigger organizations (Nilum, 20110. Without insurance it would be dif...