Most businesses will try to minimize risk through a combination of risk assessment, risk management and, where possible, transfer the risk to another party. For businesses, risks like theft, fire damage, public liability and product indemnity can be covered by insurance. Insurance companies can estimate risks accurately. For example, they have detailed statistics on many kinds of accident, how frequent events happen and what the level of compensation may be. By insuring a large cross section of businesses, insurers can be fairly certain to make a profit as mass payouts due to risks being realized simultaneously are highly unlikely. However, as pointed out by Joseph Stiglitz in his book Freefall on the financial crisis which began in 2008, innovations in the financial services sector raised some new issues on risk. The world’s largest insurer AIG had sold insurance’ in the form of credit default swaps to cover events like the bankruptcy of banks like Lehman Brothers and Bear Stearns. Without going into the detail of complex financial instruments, Stiglitz outlines how a business is likely to hold an advantage over an insurer in cases when insurance against default on debts of bankruptcy is sought. Simply put, the business is likely to have a closer view on future prospect, and thus will not buy insurance which is too expensive. This in turn drives premiums down. In the case of AIG, it had taken on so many credit default swaps which all required pay outs at the same time (due to the financial crisis) that its cash resources dried up and the company was bailed out by the US government.

Questions 

1 Based on the piece above, do you think it is possible to assess all business risks?

2 What effect might transferring risks have on decision-making and management controls?