When it comes to risk management, there are four non-insurance strategies you can put to work in your life. To make it easier for you to remember them, just think of the acronym ARRT:
- A = Avoid
- R = Reduce
- R = Retain
- T = Transfer
In the following sections, I get into greater detail on each of these.
1. Avoiding risk
Avoiding risk means exactly what it says: When none of the other strategies for treating a risk seems suitable, sometimes the wisest decision is to simply avoid the risk. I avoid risks like skydiving, hang gliding, and auto racing. I’m sure I would enjoy those activities if I ever took them up. It’s just that, for me, the rewards aren’t worth the risks.
Here are some other examples where avoiding the risk may be the best strategy:
- Not licensing a teenage driver who is clearly still immature and irresponsible
- Not buying an expensive sports car while your driving record is poor and insurance costs are sky high
- Canceling your vacation plans to a war-ravaged part of the world
- Not buying a backyard trampoline for your kids because you can’t prevent unsupervised use by other neighborhood children
2. Reducing risk
Reducing risk means taking actions that lower the probability of the loss happening at all or, if it does occur, lowering the loss’s possible severity. If you’ve inherited Grandma’s sterling silver, you can reduce the theft risk by installing a central home alarm and/or by hiding the silver well. If you have a valuable baseball-card collection, you can greatly reduce the water damage risk by mounting and sealing the cards in waterproof plastic album pages (as my son, JP, did with my card collection for Father’s Day one year).
Here are some other examples of ways you can reduce your risks:
- Regularly checking prongs on a valuable diamond ring to reduce the risk of loss of the stone
- Eating healthy foods and working out regularly, not smoking, and getting plenty of rest
- Not drinking and driving
- Buying cars with safety features like airbags and antilock brakes that test well in crash tests
Reducing risk has the advantage of being the one treatment strategy you can do the most with and have the most personal control over. It has other advantages, too. If you significantly reduce a risk:
The risk may be small enough that you feel safe avoiding insurance altogether. For example, if you’ve stored your valuables in a safe-deposit box, you may not feel the need to insure them.
You may feel comfortable carrying higher deductibles. For example, you may be able to save 50 percent on your health insurance costs by buying a $2,000 deductible, and know that a high deductible is a smart choice because your healthy lifestyle results in few claims.
You may be able to get insurance at a better cost.
3. Retaining risk
Retaining risk refers to the strategy of paying losses out of your own pocket. Retaining risk can be voluntary (such as carrying higher deductibles in order to lower your premiums). Retaining may mean choosing to take the entire risk on less valuable items; for example, you may forgo insurance on a $300 canoe. Retaining may mean not carrying insurance to cover low-frequency catastrophic losses that have almost no chance of happening where you live; for example, you probably won’t buy earthquake insurance if you live in Minnesota.
Retaining risk can also be involuntary — bad news. In this category are the surprises you get at claim time, the risks you take every day without even knowing it, such as:
- Not having any coverage to protect against an injury lawsuit from the person who delivers a package to your home-based business and falls and is injured on your icy sidewalk
- Not being protected against the lawsuit from your co-worker who was injured while riding with you in your company car
- Receiving only $30,000 for your $50,000 kitchen fire because of depreciation deductions under your homeowner’s policy
- Being sued by a car-rental company for $10,000 in damages to a rental car — damages caused by a friend or co-worker — for which you naively agreed to be responsible when you scribbled your signature on the rental agreement
- Much of the focus of this book is on uncovering these involuntary retentions — the many pitfalls of personal policies.
4. Transferring risk
Transferring risk refers to shifting the risk in whole or in part from yourself to another party. The most common form of transfer is the insurance mechanism whereby, in exchange for a predetermined premium payment, an insurance company will assume losses that you would’ve otherwise had to absorb yourself.
Here’s an example: You transfer the risk of fire damage to your home to an insurer for $800 a year. Your home is destroyed by fire. The insurance company pays the entire cost to rebuild, the cost to replace all your destroyed belongings, and even the additional costs you incur to live elsewhere while your new home is being rebuilt.
The other type of transfer (the bad kind) occurs in just about every contract you sign in your daily life. “But I never sign contracts,” you’re thinking. Really? I bet you do — we all do. In any given year, you likely sign contracts for an apartment lease, a boat rental, a vacation condo, a rental car, a credit card, a real estate purchase, or a home-repair proposal.
These are just some examples of the contracts you sign in your daily life. I could give you many more. It’s almost impossible to be alive and not sign contracts in today’s busy world. In just about every one of these contracts, someone is trying to transfer some kind of risk to you, often without your knowledge. If there’s a problem, you’re simply out of luck. Courts don’t accept failure to read what you’ve signed as an excuse.
Take a closer look at two types of everyday contracts in which you assume responsibility unknowingly, and the surprises that can be waiting for you.
Renting a chainsaw from a hardware store: You assume absolute liability for damage to the saw, even if it’s not your fault, as well as all liability for injuries to another person (for example, a friend using the saw), even if the injury was caused by a defect in the saw. You also release the store from responsibility for your injuries, even if they’re caused by a defect in the saw.
Wedding reception catering: You assume all liability for injuries to guests, even when they’re caused by the negligence of the restaurant (for example, food poisoning). You agree to pay all defense costs of the restaurant in such injury lawsuits and to pay any judgment against the restaurant out of your own pocket.
Can you imagine how upset you’d be if some dear friends at your daughter’s wedding reception suffered serious illness or even death from contaminated food, and you were forced to pay to defend the restaurant? Plus, you had to pay all judgments against the restaurant, just because you innocently signed a contract to do so?
Does this scare you? I hope so. Fear is a good thing when it keeps you from hurting yourself. And if you don’t start paying attention to the routine contracts of your daily life, you could easily assume a risk that can ruin you financially.
Putting ARRT into Action: A Case Study
The four risk treatment strategies of avoid, reduce, retain, and transfer work together. In fact, you’re more likely to combine the strategies instead of using them individually.
Here’s a case study that’s just one example of how you can put ARRT into action in your daily life: Let’s say your son is about to turn 16, and he wants to get his driver’s license.
You can obviously avoid the risks associated with a 16-year-old driver by not allowing him to get a driver’s license. Other methods of avoiding this risk include chaining your teenager in the cellar or giving him up for adoption — but I’m guessing that, no matter how annoying his attitude can be at times, you’re not quite ready to get rid of him.
Avoiding is the strategy to take when none of the other strategies for treating a risk seems suitable. Odds are, when it comes to your teen, you’ll be able to manage the risk through a combination of the other three strategies and allow him to drive. (And no, he didn’t put me up to this.)
You can reduce the risks of injuries, property damage, and lawsuits by:
- Requiring your teenager to spend 30 or 40 hours of practice behind the wheel, alongside you, while facing all different driving scenarios and weather conditions.
- Buying him a structurally solid and mechanically safe car, with working seat belts and air bags, to minimize injuries.
- Asking your teen to sign a contract such as the Students Against Destructive Decisions (SADD) Contract for Life, where he agrees not to drive after using drugs or alcohol, and you agree to pick him up anytime, anyplace, without giving him a hard time.
You can retain some or all of the risk of damage to the car itself (collision, fire, theft) by either not buying damage insurance on the car at all or, if the car is worth too much, at least choosing large deductibles. This strategy will save you a bundle on your insurance costs.
You can transfer the ownership risk of personal lawsuits related to vehicle maintenance by transferring the vehicle title and maintenance responsibility to your teenager. This strategy won’t absolve you of responsibility for your teen’s behavior, but it can avoid lawsuits against you related to not maintaining the vehicle in a reasonable manner. Your teen has considerably fewer assets and income than you do and is much less a target for lawsuits than you are, so he’ll need far less liability insurance coverage.