Risk transfer

Category: Risk management frameworks · Reviewed by Taylor Watts, Broker · New Business · Last reviewed

Risk transfer

Risk transfer is the process of shifting some or all of the financial consequence of a risk to a third party. It is one of the four classical treatments in ISO 31000 and the dominant commercial application of insurance.

Mechanisms

1. Insurance — the insured pays a premium in exchange for the insurer paying defined losses. The default form of risk transfer for most commercial enterprises.
2. Reinsurance — insurer-to-insurer transfer, structured as proportional or non-proportional treaties.
3. Contractual transfer — hold-harmless clauses, indemnities, limitation of liability, transfer of risk to suppliers (e.g. via service agreements, leases, construction subcontracts).
4. Capital markets — catastrophe bonds, industry loss warranties (ILWs), insurance-linked securities (ILS), sidecars.
5. Captive insurance — formal transfer to a related insurer for tax, control or capital reasons (the economic risk often remains in the group).

What transfer is not

Risk transfer does not eliminate risk. It substitutes:

• Counterparty credit risk on the transferee.
• Coverage / wording risk (exclusions, sub-limits, conditions precedent).
• Moral hazard (the insured may take less care than uninsured).
• Reputational risk (insurance does not cover all the consequences of a loss).

Boards that treat insurance as “risk eliminated” are mis-managing their residual risk.

References

• ISO 31000:2018.
• IFoA (2017). A Practitioner’s Guide to Reinsurance.
• Insurance Act 2015 (statutory framework for insurance contracts in England, Wales, Scotland and Northern Ireland).

Cross-references

• Risk treatment
• Reinsurance pricing
• Residual risk

Maintained by Matt Bartlett, Director, Apex Insurance Brokers Limited. FCA FRN 724952. Companies House 07014570.