CHAPTER 2: THE CLIMATE OF THE SOUTH AFRICAN INSURANCE INDUSTRY OVERVIEW
2.3 RISK RESPONSES
According to Outreville (1998), in response to a need for protection against the risk of losses, the insurance industry emerged. This means that an individual can shift the financial risks to
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an insurance company as a response to exposure. Primarily, insurance is a form of risk management used to hedge against the uncertainty of a loss (Kendrick, 2009). Generally, people have a misconception of what risk management is as they tend to view it as simply buying insurance. However, several risks that an insurance company cannot insure can be catered for by several risk responses. The following section explains:
2.3.1 Risk avoidance
Risk-taking or its inverse, risk avoidance, is frequently mentioned by risk practitioners.
According to Gatzert et al. (2016:641), risk avoidance refers to the complete elimination of activities or decisions that may cause harm or negatively affect one’s financial assets. In a similar vein, Shahzad (2010) defined it as an informed decision not to be involved in or to withdraw from activity to not be exposed to a particular risk. Risk avoidance is also considered the most effective way to prevent risks because risk is completely avoided (Dinu, 2013). Also, Wang and Wen (2012:185) highlighted that an individual could avoid the risk of getting involved in a car accident by simply not driving the car. Similarly, an individual would avoid the risk of losing their phone while jogging by leaving it at home. This risk response is ideal for risks that tend to cause a severe impact on a project or business (Antonites & Wordsworth, 2009:69).
2.3.2 Risk mitigation
Virdi (2005) stated that risk could not be avoided altogether; however, it can be mitigated. Risk mitigation or risk reduction refers to the minimisation of activities that may be harmful to one’s health or possessions or lead to a major loss (Gatzert et al., 2016:642). It is the most common way most businesses choose to deal with their risks (Ward, 2001:7). It is important to also emphasise that reducing risk is not entirely sufficient in managing risks as it minimises the risks, not eliminates them (Rao & Metts, 2003). This approach is established on the fundamental principle that action taken to reduce harmful risks is more effective than fixing damages after the risk occurs. According to Lai (2014), individuals can reduce the amount of damage or losses certain risks can have. This can be achieved by incorporating specific adjustments to the life of an individual. Harner (2011:470) further elaborated, stating that the risk of getting injured in an accident can be mitigated by wearing a seatbelt in a car.
38 2.3.3 Risk assumption
According to LiPuma and Lee (2004), risk assumption is a risk management technique generally referred to as risk acceptance or self-insurance. Aiuppa (2001:16) further defines self-insurance as the act of establishing a monetary fund that can be used to cover the loss caused by a risky event. Moreover, risk assumption can be defined as a situation whereby an individual or business would predict the likelihood that losses or a threat could occur but takes action to protect against these losses (Besar et al., 2011). Several researchers, Repullo (2005:47), Olsson and Spejelkavik (2014:197), refer to risk assumption as a last resort. This means that risks cannot be avoided or mitigated but accepted or assumed. According to Ahmed et al. (2007), accepting risk means simply dealing with the consequences that come with the risks.
2.3.4 Risk shifting
The most popular and most effective way of dealing with risk is to shift or transfer it to an insurance company. The insurance company pledges to cover the loss to an individual’s possession at a specific cost (Tavares, 2002:18). The fee that the insured pays to an insurance company is commonly paid once a month and is known as a premium (Huang et al., 2011).
The two participants, the insurer and the insured sign a contract called an insurance policy, and the insured is referred to as an insurance policyholder (Gilje, 2016). Risk shifting, therefore, entails the shifting of losses from the policyholder to the insurer (Aiuppa 2001:16).
Huang et al. (2011) state that in most cases, the insurance policy is drafted for one year thereafter, the policyholder can renew it each year. The contract specifically stipulates the payable premium as well as the losses the insurance will cover. Insurance is, therefore, an agreement between the insurer and the policyholder which stipulates that the insurer will protect the policyholder against losses at a given fee (Halek & Eisenhauer, 2001:1). However, insurance companies will not cover all kinds of risks; some are insurable risks while some are uninsurable risks. Insurable risks are risks that the insurance company will be able to cover, such as the risk of loss by fire, theft, accident, sickness and death (Halek & Eisenhauer, 2001:24).
On the other hand, uninsurable risks are the risks insurance companies will not cover. These risks are commonly known as speculative risks (Yoo, 2014:727). For example, an insurance
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company will be able to protect a shop owner against losses due to a fire but will not be able to protect the shop owner against losses resulting from low sales of the goods sold.
Figure 2. 2: Graphical representation of insurable and uninsurable risks faced by businesses and individuals
Source: Risk Management and Insurance (2016:4)
As shown in Figure 2.2 only pure risks are insurable, the following section elaborates on the two types of insurance, short-term and long-term.