Transfer Of Risk

You're walking through wolf-infested woods with a large package of raw meat in your backpack. You start to get a little nervous, so you move the meat to someone else's pack. Transfer of risk.

The financial version of the term works much the same way. The goal is to move the consequence of an unfavorable event onto someone else. Something goes wrong, but you don't have to pay for it. Someone else does. That situation defines a transfer of risk.

The most obvious example involves insurance. When you get an insurance policy, you're effectively conducting a transfer of risk. Now, if your car gets wrecked in an accident, or your house gets wrecked by a coordinated beaver attack, you don't have to pay to get it repaired. The insurance company does.

Insurance companies pull this maneuver as well. They don't just sit on all the risk they have. They look to transfer it. So insurance firms enter into reinsurance contracts with other companies, transferring a portion of their risk onto another firm.