Trading Skills

5 Basic Approaches to Risk Management

As people begin to age, they typically experience more health risks. Managing pure risk requires the process of identifying, assessing, and controlling those risks—a defensive strategy to prepare for the unexpected. The basic approaches to risk management—avoid, retain, share, transfer, prevent and mitigate—can be applied to all aspects of an individual’s life, and can pay off over the long term. Here are the five approaches and how they apply to health risk management.

key takeaways

  • Avoidance means not engaging in activities that could harm you; in terms of health, smoking is a good example.
  • Reservation acknowledges the inevitability of certain risks, and when it comes to health care, this can mean choosing a cheaper health insurance plan with a higher deductible.
  • Risk-sharing can be applied to employer-based benefits that are often more affordable than individuals getting their own health insurance.
  • Transferring risk is relevant to health care, as medical expenses are transferred from the individual to the insurance company beyond the cost of premiums and deductibles.
  • Prevention and loss reduction are used to minimize risk, not eliminate it – the same concept is used in healthcare for preventive care.

avoid

Avoidance is a method of reducing risk by not engaging in activities that could lead to injury, illness, or death. Smoking is an example of such an activity, as avoiding smoking may reduce health and financial risks.

According to the American Lung Association, smoking is the leading cause of preventable death in the United States, claiming more than 480,000 lives each year.In addition, the Centers for Disease Control and Prevention states that smoking is the number one risk factor for developing lung cancer, and the longer people smoke, the risk only increases.

Life insurers mitigate this risk by raising premiums for both smokers and non-smokers. Under the Affordable Care Act, also known as Obamacare, health insurers can raise premiums based on age, geographic location, family size and smoking status. The law allows for a premium surcharge of up to 50% on smokers.

Risk management strategies used in the financial world can also be applied to manage your own health.

Reserve

A reservation is an acknowledgment and acceptance of a given risk. Often, this acceptable risk is to help offset the cost of greater risk in the future, such as choosing a lower-premium health insurance plan with a higher deductible. The initial risk is having to pay more out-of-pocket medical bills if a health problem arises. If the problem becomes more serious or life-threatening, health insurance benefits can be used to cover most of the costs beyond the deductible. If an individual does not have a serious health problem that would require paying any additional medical bills, then they avoid out-of-pocket costs, reducing the greater risk entirely.

share

Risk sharing is often implemented through employer-based benefits, allowing companies to pay a portion of the insurance premium with employees. Essentially, this shares the risk with the company and all employees participating in insurance benefits. The understanding is that as more participants share risk, premium costs should shrink accordingly. If possible, individuals may find it in their best interest to share risk by choosing an employer health care and life insurance plan.

transfer

The use of health insurance is an example of transferring risk, as the financial risk associated with health care is transferred from the individual to the insurance company. Insurance companies take financial risk in exchange for a fee called a premium and a written contract between the insurance company and the individual. The contract sets out all the stipulations and conditions that the insurance company must meet and maintain in order to assume the financial responsibility for taking the risk.

By accepting the terms and conditions and paying the premium, the individual manages to transfer most, if not all, of the risk to the insurance company. Insurers carefully apply many statistics and algorithms to accurately determine the appropriate premium payment commensurate with the coverage required. When a claim is made, the insurance company confirms that the conditions for providing contractual payment for the risk outcome are met.

loss prevention

This approach to risk management attempts to minimize losses rather than eliminate them entirely. While accepting risk, it remains focused on containing losses and preventing them from spreading. An example in health insurance is preventive care.

Health insurers encourage preventive care visits, which are often free, and members can receive annual checkups and physicals. Insurers understand that early detection of potential health problems and implementation of preventive care can help minimize long-term medical costs. Many wellness plans also offer discounts to gyms and health clubs as another preventative and reduced means to keep members active and healthy.

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