Risk Management

Defining risk avoidance versus risk reduction: what you need to know

By October 6, 2022No Comments

Defining risk avoidance versus risk reduction: what you need to know

As a business owner, you’re no stranger to risk or hard work. Starting your own business might have been a big risk, and you make big and small business decisions daily that involve risk.

A critical component of protecting your business from unexpected financial loss is managing those risks effectively. But there’s no one-size-fits-all solution to small business risk management. 

There are various ways to manage risk, and you may choose different strategies based on the severity of the threat to your bottom line.

One way to protect your business is to avoid risk, which sounds good in theory, but has some downsides. The other is to lessen existing risks.

Let’s look at how risk avoidance and risk reduction work to decide if it’s the right choice for your business.

What is risk avoidance?

Risk avoidance works pretty much as it sounds. You eliminate your business’s exposure to a specific risk to avoid the potential losses it could bring.

No doubt, avoiding exposure can help you minimize potential negative financial consequences. There may be times when risk avoidance makes sense. For example, if a risk would bankrupt your business or the cost to mitigate it would put you in the red.

What are examples of risk avoidance?

 While avoiding all risks may not be the best solution for your business, there may be some risks you simply won’t accept because the potential for loss is too great — and that’s okay. Here are a few examples of what risk avoidance may look like in different businesses.

  • A landscaping companyelects not to trim or cut down trees near power lines and lets the utility company handle it.
  • A residential contractorrequires homeowners to temporarily move out of their homes during large-scale renovation projects (e.g., raising the roof) to avoid the risk that someone living in the house will be injured.
  • A cleaning business ownerchooses not to provide services requiring hazardous chemicals because of their risk to both employees and customers.

Be mindful though; avoiding risks also limits growth opportunities.

The good news is you don’t have to avoid all risks to run a sustainable and profitable business. You may be able to reduce it instead.

What is risk reduction?

 Since avoiding risk can slow growth and reduce profitability, reducing risk in your small business may make more sense than avoiding it altogether.

You don’t eliminate exposure to a specific risk with risk reduction. Instead, you take steps to minimize the likelihood it will happen and the impact it may have on your business if it does.

There are many ways to reduce risk within an organization, including:

  • Conducting employee training
  • Implementing safety protocols
  • Creating internal checks and balances
  • Maintaining adequate business insurancecoverage

Implementing the right risk reduction procedures can help lower your risk to a level you can live with — without eliminating potential opportunities for your business.

What are examples of risk reduction?

Just because you can avoid a risk doesn’t mean it’s the right choice for your business. Sometimes, it may make more sense to take steps to reduce the risk of a specific exposure without eliminating it. For example:

  • A restaurant owner who provides food delivery service has drivers who could get into an accident at any time. Instead of discontinuing delivery, the owner requires all drivers to take a safe driving class.
  • A consultant uses a contract to clearly outline the scope of each project, including the deliverables, what the client will provide, payment terms and timeline. Being as detailed as possible helps reduce the likelihood that a client will file an errors and omissions claim for not completing the work as agreed.
  • A contractor rents or leases (instead of buying) expensive equipment for specific construction projects instead of giving up on opportunities that need it.

How do you balance risk avoidance vs. risk reduction?

 Deciding which risks you’re willing to reduce and which you can’t live with is a balancing act.

Avoiding too many risks could limit the possibilities for growth and profit within your business. However, accepting too many could lead to financial losses you can’t recover from.

But why limit yourself? You don’t have to either accept or eliminate all risks. You can do both. Here’s how.

  • Identify the risks that pose too great of a threat or cost too much to reduce and eliminate.
  • Identify the risks you could live with if you reduced them. Reduce them to a level you’re comfortable with.
  • No law says you must assume whatever risks are left exposed by yourself. That is what insurance is for. In exchange for paying a premium, the insurance company assumes the risk of a specific loss up to the policy limit.

You could choose to eliminate some risks by not providing services to certain types of industries or NAICS classifications. However, keep in mind that this action could limit your opportunity to grow your business and earn more.

About CMR | PolicySmart®

PolicySmart’s risk management consultants provide independent group benefit, retirement and commercial insurance advice by reviewing your current portfolio of policies to improve coverage and reduce cost. By using our proprietary database – The CMR Database® (comprising some 13,000 brokers and specialists globally), we maximize access to the insurance and retirement industry providing greater options that will translate to better coverage and lower cost.

Please email croche@policysmart.app or call 888-873-1982 or 212-447-4300 for more information.  www.policysmart.app