Insurance is a form of risk management used to ‘hedge’ against the risk of a contingent, ‘Uncertain loss, or a loss which may not occur. In technical terms, ‘hedging’ is a technique of taking a position (making an investment) in one market which is specifically intended to offset or balance the losses that may be incurred by another position or investment. Various forms of risk can be protected against with a hedge, including commodity price risk, credit risk, currency or foreign exchange risk, interest rate risk, equity risk and customer demand risk. Hedges can be constructed using a range of financial instruments, including forward exchange contracts for currencies; futures contracts, options and derivatives (e.g. to hedge against movements in commodity or share prices) and insurance.
Insurance is defined as ‘the equitable transfer of the risk of a loss from one entity to another, in exchange for payment. Premiums (amounts charged for a certain amount of insurance coverage) are paid by the insured party (or insurance policy holder) to an insurer (the company selling the insurance).
A wide range of insurance covers are available, for risks such as the following.
• Theft and fraud
• Damage to property
• Fire and flood
• Marine (Shipping), aviation (air) and motor (road haulage) transit insurance
• Public liability (if a member of the public suffers an injury on the insured party’s premises)
• Product liability (if a member of the public Suffers injury through use of a product)
• Employer’s liability (if an employee suffers injury or illness at work).
Benefits of insurance
Insurance does not address the underlying risks, hazards or vulnerabilities and is therefore certainly not a substitute for robust risk assessment and mitigation. However, insurance:
• Reduces the financial impact of a risk event. (This is sometimes called ‘hedging’ against risk.)
• Aids recovery, by providing funds to replace lost or damaged assets,
• May satisfy customers, suppliers and other key stakeholders: funds are available to mitigate any losses to them (e.g. through liability insurance) or which would otherwise be passed on to them (e.g. insuring goods in transit)
• May be required by the contract of purchase or sale (e.g. to ensure that a supplier is able to cover its liabilities to the buyer)
• May be required by law. (Employer’s liability insurance, for example, is a statutory requirement in Kenya.