Risk Transfer

In addition to avoiding risks, an organization may manage associated risks by transferring the risks. Risk transfer is a risk management strategy that transfers the risks associated with a particular process or activity from one party to another. For example, those of us who own a car realize we are at risk for having the car damaged by an accident, or we may cause damage to another person or property if we are deemed to be at fault for the accident. In the event you are in an accident, the consequences could be severe, requiring you to incur huge financial loss. 

Most states recognize the potential costs associated with motor vehicle accidents can be catastrophic to both the initiator of the accident and the victim. Therefore, state laws as well as financial institutions require owners/operators of motor vehicles to transfer these risks. Insurance companies are more than willing to accept the risks associated with you owning and operating a motor vehicle for fair compensation. Through a formal agreement, aka a policy, the insurance company agrees to assume the liability, or risks for your action of owning/operating a motor vehicle. 

A second method of risk transfer is through indemnity. Indemnity is defined as security against or exemption from liability. An indemnity clause is a contractual provision in which one party agrees to assume liability that the other party may incur. If you enter into a contract with an outside organization. There may be a clause in the contract which states the contractor will indemnify your organization against a specified risk.  For example, your organization enters into a contract with a construction company for a new sidewalk on your property. For some reason the sidewalk is uneven and a patron trips and falls suffering an injury. It may be wise to have an indemnity clause in the contract stating the contractor will assume all liability resulting from the construction of the new sidewalk. 

An indemnification clause is one contractual method of risk transfer. Another method is a performance clause or bond. Assume you are making a major capital purchase. Your organization is purchasing a new machine needed to improve production of your organization. To receive the best price you issue a request for proposal from the manufacturers. A stipulation included in the proposal is a performance bond. An insurance company, or other financial institution issues a performance bond to the contractor whom you are purchasing the equipment. The performance bond is invoked if the equipment does not meet specifications or fails to perform as specified. The bond company is assuming the risks and liabilities associated with the equipment’s failure to perform. 

Why transfer risks? Transferring risks takes the potential liability of an incident or event from your organization and drops it in someone else’s hands. Thereby protecting your organization from exposure to litigation and financial losses. The elements of an effective risk transfer policy include:

• Require certificates of insurance from subcontractors, tenants, service providers and other parties.
• Determine appropriate insurance coverage and limits.
• Develop a system that enables an annual review of certificates of insurance for multi-year relationships prior to the work starting.
• Enforce certificates of insurance requirements.
• Create a certificate of insurance filing system for annual review.