What is 'Transfer Of Risk'

A transfer of risk, considered the underlying tenet of insurance transactions, is a risk management technique where risk shifts from one party to another. Risks may transfer between individuals, from individuals to insurance companies, or from insurers to reinsurers.  For example, when a person purchases home insurance, they are paying an insurance company to assume the risks associated with homeownership.

BREAKING DOWN 'Transfer Of Risk'

When purchasing insurance, the insurer agrees to indemnify a policyholder up to a certain amount for a specified loss in exchange for payment.  In general, most insurance companies collect millions of dollars in premiums annually. The premiums compensate the insurance provider for administrative and operating expenses, death or other benefits they must pay out, and profits for the company. 

Since claim payouts may be substantial, insurers rely on actuarial statistics and other information when projecting the number of deaths per year. Because this number is relatively small, the company anticipates total premiums received to exceed death benefits paid. Furthermore, an insurer’s probability of sustaining financial loss after a policyholder’s death is minimal compared to the likelihood of a family suffering financial loss when an income-earning member dies.

Risk Transfer to Reinsurance Companies

When insurance companies assume too much risk, they often transfer some of that risk to reinsurance companies. For example, an insurance company without reinsurance may write $10 million in limits on a policy. With reinsurance, the insurance company can underwrite policies for higher amounts as they cede part of the ceiling exceeding $10 million to the reinsurer. If the insurance company pays a claim exceeding $10 million, the reinsurer pays the insurer part of the excess, as stated in the contract.

Property Insurance Risk Transfer

Purchasing a home is likely the most significant purchase an individual will make. To protect their investment, most homeowners will buy homeowner's insurance. With homeowner's insurance, associated risks transfer from the homeowner to the insurer.

Insurance companies assess risks to determine insurability and premiums. For example, underwriting insurance for a customer with a compromised credit profile and several dogs is riskier than insuring someone with a perfect credit profile and no pets. The policy for the first applicant will command a higher premium because of the transfer of risk from the applicant to the insurer is higher.

  1. Underlying Retention

    Underlying retention is the net amount of risk or liability arising ...
  2. Personal Lines Insurance

    Personal lines insurance includes property and casualty insurance ...
  3. Time And Distance Policy

    A reinsurance treaty in which a ceding insurer transfers a lump ...
  4. Blended Covers

    Blended covers are a form of reinsurance that combines features ...
  5. Target Risk (Insurance)

    Target risk assets are classes of assets excluded from coverage ...
  6. Cession

    Cession refers to the portions of obligations in an insurance ...
Related Articles
  1. Insurance

    The Business Model of Reinsurance Companies

    Learn about the business of reinsurance, a hidden industry that underpins the entire financial and insurance structure around the globe.
  2. Insurance

    Facultative vs. Treaty Reinsurance: Differences and Examples

    Reinsurance companies offer insurance to other insurers in case the traditional insurer does not have enough money to pay claims against its written policies.
  3. Insurance

    When Things Go Awry, Insurers Get Reinsured

    Guru Warren Buffett is making this sector popular. Learn more here.
  4. Insurance

    The History of Insurance in America

    Insurance was a latecomer to the American landscape, largely due to the country's unknown risks.
  5. Insurance

    How Much Life Insurance Should You Carry?

    Before purchasing life insurance it is important to decide if you really need it, what type of policy is best, and how much coverage you should get.
  6. Insurance

    12 Car Insurance Cost-Cutters

    Car insurance rates are on the rise. If car insurance costs are dragging you down, use these tips to free yourself from some of the extra weight.
  7. Insurance

    Term Life Insurance: Everything You Need to Know

    Term life insurance is an affordable way to financially protect your loved ones after your death. Here's what you need to know before purchasing a policy.
  8. Insurance

    Why Insurance Is Not An Investment

    Insurance protects you financially from risk but should not be considered an investment.
  1. Can your insurance company cancel your policy without notice?

    Learn about your rights as an insured when it comes to your insurance policy being canceled, including how to access your ... Read Answer >>
  2. What are insurance sector companies usual profit margins?

    Understand what the average profit margin for a company that serves in the insurance sector and what factors can affect the ... Read Answer >>
Hot Definitions
  1. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  2. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  3. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  4. Current Assets

    Current assets is a balance sheet item that represents the value of all assets that can reasonably expected to be converted ...
  5. Volatility

    Volatility measures how much the price of a security, derivative, or index fluctuates.
  6. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
Trading Center