Risk Transfer – A Response Strategy for Limiting Damage from a Negative Event

An article published in early 2017 giving a brief overview of risk response strategies has been one of my most popular…and it still resonates with risk management professionals.

I’ve wanted to dive deeper into each of these risk response strategies to provide readers with a little more background on how a particular one applies to enterprise risks.

Risk transfer is the first one I’ll be talking about…

If you go to Google and search for risk transfer (here, I did it for you), you’ll find lots of information about insurance and indemnification provisions in contracts. This article will have some information on these, but will rather focus on other approaches for transferring strategic, talent, and other enterprise risks.

One important point to cover before discussing different types of risk transfer is…

You have to identify, assess, and then analyze risks using your organization’s risk tolerance to have a baseline for determining the right risk response strategy.

The analysis results can be one of two things:

  • Within your risk tolerance
  • Outside your risk tolerance

Nothing needs to happen if the risk falls within your risk tolerance.

But if it falls outside your risk tolerance, more analysis will be needed to determine how much is within your control and which elements of a risk are transferable.

Now the first impulse for many is to obtain coverage for insurable risks. While this form of risk transfer is useful in many situations, it should be viewed with caution. As explained by Norman Marks in his book World-Class Risk Management, insurance will only cover financial losses, but not other impacts such as reputation, talent, or lost-time.

Also, insurance doesn’t reduce the risk to within your tolerance level…it just helps address the financial impacts should the covered event occur, which brings us to another word of caution about insurance. Any policy is going to have exclusions and coverage limits and will not always pay the full costs. This is especially true if it’s determined the insured is partially at-fault.

While insurance and indemnification through a contract receives the most attention, there are two other options organizations can consider for transferring risks. These include: outsourcing and entering into partnerships.

Outsourcing – You’ve probably heard this word a lot in the corporate world, but I’m not sure how many see it as a way to transfer risks.

The best way to think about outsourcing is that it contractually transfers risk to another entity. A contract will include language like “shall assume…” and have other hold harmless provisions.

For example, your organization uses software tools for a variety of tasks. Software is available as either a stand-alone tool that is hosted by your organization (also known as “on premises”) or is cloud-based and hosted by a third-party (a/k/a SaaS).

For some, the on premises version is preferable because they want to keep as much in-house as possible. By doing so though, the organization is assuming ALL risks associated with the software, including sensitive customer information.

By “outsourcing” this tool to a cloud-based provider, risks like data security, maintenance, and others are transferred from your organization to the service provider through a contract.

Another example could be developing an employee training program. In order to retain the best talent, many organizations will invest in personal development and other programs. Developing this program is a huge task, and since it falls outside of the organization’s core competency, an outside expert can be hired to deal with the initial development of a solid training program, thereby also managing many risks around training employees.

But wait. You are likely thinking that the cost to outsourcing to an expert will cost more than handling it in-house. It is definitely possible. I call this the “cost” of transferring the actions necessary to reduce your organization’s risk. While your organization will still ultimately own the risks related to the employee training program, the time and energy needed to determine the best approach, program design, set-up, and implementation (and that is a lot of energy and time!) is handled by the outside expert.

A couple of warnings about outsourcing:

1). In my former corporate role as an ERM professional, I had this saying that “…you can outsource the process, but you can’t outsource the risk.” In other words, you can transfer a risk, but you could still be affected should it come to pass. You may be able to transfer the liability and financial impact of a risk, but reputation and other impacts will need to be factored into decisions.

For example, several automakers outsourced the manufacture of their airbags to Takata. Although the manufacturer is responsible for the defect that would cause some airbags to explode and hurt passengers, automakers like Ford, Toyota, and others will still have to deal with the reputational fallout and any impacts on their stock price.

Which leads us to the next warning…

2).  It’s important that your organization understand the risk management practices of the vendor. In my experience and according to Norman Marks, management will have little awareness to how the third-party manages risk. Organizations have to determine how robust the third-party’s risk management practice is. You will not be able to claim complete innocence if the vendor wasn’t properly handling risks for services they are providing. Therefore, I highly encourage you to understand your both current and prospective vendors how they address specific types of risks.

Forming partnerships – Another way to transfer risk is to partner with another company or to find an investor to either relieve the financial burden of a risk or fill in areas where you are weak (i.e. expertise or resources).

Let’s say you want to enter a market in a new country. This country is going to have its own culture, its own laws, and other factors to consider. It would be dangerous to try and navigate this on your own, so you partner with an organization in that country with experience in “local” matters like this. You are in effect transferring these particular risks to the organization you partner with.

One example of forming partnerships to transfer risk is in the airline industry. Delta and American airlines resumed an agreement in early 2018 that allows them to rebook passengers on the other air carrier in the event of delays or cancellations. This doesn’t eliminate a risk from occurring mind you, but it does help the carriers keep their passengers moving toward their destination and not sitting around the airport.

Transferring risks to another entity through insurance, outsourcing or a partnership should be approached with caution!!

Coverage limits, exclusions, contract language, and oversight of the other party’s risk management practices are crucial to ensuring the risk is truly transferred out of your hands.

In what ways, besides insurance, has your organization transferred a risk to another party? Have you ever experienced non-financial impacts from a risk you transferred?

I’m interested to hear your thoughts on this important topic. Please feel free to share your perspective in the comments below or join the conversation on LinkedIn.

And if you’re seeking ways to transfer risks in an effective and safe way but don’t know where to start, please contact me to discuss your situation and possible solutions today!

 

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