Risk Management Methods

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There are five basic methods that can be used to manage risk: 

1. Risk Avoidance

Risk can be managed by simply avoiding it. Residential risk in countrties with political instability can be avoided by not residing in those countries. Similarly, one can avoid the risk of dropping out of school by opting not to attend school inthe first place, or avoid the risk of a car accident by not riding in a car. While avoidance may be an acceptable method of managing risk in some cases, it clearly is neither possible nor practical to avoid all risks. For example, if one lives 30 km aways from one's workplace, it will not be practical to avoid the risk of a motor acccident by walking to work everyday. 

2. Risk Retention
Risk can also be managed by retaining it. An individual or a business firm may retain all or part of a given risk they are exposed to. In this respect, risk can be retained in 2 ways - active risk retention and passive risk retention. With active risk retention, the individual is aware of the risk and intentionally chooses to retain all or part of it. For example, people who purchase major medical insurance are aware of the co-insurance and deductibles they are responsible for in exchange for the lower premium. 

Risk may be retained because of ignorance, indifference or simply procrastination. These are instances of passive risk retention. This is undesirable, especially if the risk can lead to substantial financial loss. This is particularly true in the case of long-term disability where many people are not aware of the high chance of becoming disabled and the financial impact of long-term disability.

3. Risk Transfer

Instead of avoiding or retaining the risks, we can also transfer risks by way of contracts and incorporation of a business firm. When you rent a house and you do not want to take the risk of being removed from the house sooner than expected, you can enter into a contract or a lease with the landlord for the desired period of stay. Likewise, you can also transfer the risk of your newly purchased personal computer breaking down by securing a warranty from the manufacturer for defective parts and labour. 

A sole proprietor who wishes to protect his personal assets from the creditors of the sole proprietorship can incorporate a limited liability company to operate his business. In this way, incorporation limits the liablilty of the shareholders of the company and avoid the risk of the shareholders losing their personal assets to satisfy the debts arising from the business operation. 

4. Loss Control

Loss of control is another method of managing risks. Loss control involves taking steps to prevent or reduce the frequency of losses and to contain the severity of losses. Loss control therefore has two objectives, namely, loss prevention and loss reduction.

There are always preventive measures that can be taken to avoid or at least reduce the chances of losses. For example, if you have to drive, make sure that you do not drink heavily or are not overly tired.

Although strict preventive measures can reduce the frequency of losses, some losses will inevitably occur. Thus the second objective of loss control is to reduce the severity of a loss if it occurs. For example, motor cycle riders in Singapore are required to wear safety helmets to protect them from severe head injuries if an accident occurs.
5. Insurance 
Making sure that you do not lose whatever you have worked hard for is another important part of an effective personal financial plan. This is waht insurance is all about. Insurance is a critical part of the planning process because it provides protection for both income (like life, health and disability insurance ) and assets ( like property, ar and liability insurance). One serious illness or mishap can wipe out everything you have earned over the years.