It is a common mistake to think of insurance policies as a tool for risk mitigation. That way of thinking is wrong. Insurance policies alone are not a replacement for risk mitigation and risk management strategies. In this post, you will learn why an insurance must always be just another tool in your arsenal, and never a strategy of its own.
This post is as personal as it gets. Seriously, I can’t think of something more personal to share as an example.
On May 2018, my wife and I were scheduled to take a four weeks vacation, which we planned for a whole year.
We had everything in place – the flight tickets, the hotels, car rental, I mean everything.
One thing we also (luckily) had was a travel insurance that covers changes and cancellation due to medical situations. I purchased the insurance the day after we purchased the flight tickets (three months before our vacation). Good thing that I did.
48 hours before our scheduled departure I was diagnosed with Chicken Pox and was forbidden from flying (or even leaving home), that came after several hours at the ER isolation room, so that the medical staff can determine exactly what I had. It looked like a scene from a movie. All the doctors that come to check me, were all dressed up in biohazard suites, with their masks on… Strangely, It was rather hilarious than anything else. I was home several hours later with a strict order not to leave my house for a week. Of course we had to cancel our flights (all of them including connection) and hotels that we already booked. Some of them we could cancel without any problems, but some were non-refundable which forced us to pay, despite the fact that we could not arrive.
Thank god we had an insurance…
Having an insurance in place allowed us to get our money back, after filling up some paper work proving the exact amount of money we lost due to our unfortunate situation. Simply put, we paid the money, then got it back from our insurance policy to mitigate the loss of money.
However, having insurance in place did not mitigate the chance (or in other words, reduce the risk) of me getting sick. It only transferred the fiscal liability of such event to the company who issued the insurance policy. In order for me to reduce the risk, I could vaccinate myself. However, purchasing insurance did nothing more than to transferring the risk to the insurance company. By the way, I did take 2 vaccinations after consulting a doctor, but they were not for Chicken Pox, it simply didn’t seemed likely, at the time, that I will catch it. It teaches us a bit about risks we can predict, and the ones we can’t (known unknowns, and unknown unknowns).
Let’s see what this incident can teach us about insurance, and how it can fit into our overall risk management strategy.
Insurance only transfer the liability of the risk
Just as purchasing insurance policy had nothing to do with reducing the risk of me getting chicken pox, so does purchasing insurance for any risk you identify during you project lifecycle.
In other words, purchasing an insurance policy simply means that
- You identified the risk, as part of you risk identification process.
- You decided that the risk was significant enough to do something about it
- You were able to put a price tag on it
- You decided that you are better off paying the policy fee than suffering the entire lost, in case the risk occurs.
If the latter does occur, that the insurance company will cover your loses, according to the term of the policy.
As you can see, noting in the above list has anything to do with reducing the chance risk triggers will occur, which is the practice of risk mitigation.
Risk mitigation simply means that you take proactive measures to reduce likelihood of hitting, or activating risk triggers. In other words, you take efforts of avoiding the risk by allocation the appropriate resources to that task.
Can we get Insurance to protect us from what we do not know?
Sort answer is now. But the reality, as always, is more complicated.
There are two major ways to budget a project
- Top to bottom – We have X amount of money to do Z.
- Bottom to top – We estimate how much money it will cost us to complete each task, then we aggregate.
Either way, two types of additional money should always be available to the project.
- Contingency reserves – That is “extra” money we budget into the project to protect us for risks, issues we can predict.
- Management reserves – That is a certain amount of money that management put on top of the project budget, not available or accessible to the project, to help the organization and the project deal with risks or event that they could not, and fif not predict.
In other words, contingency reserves purpose is to deal with “known unknowns”, management reserves purpose is to deal with “known unknowns”. Since it is impossible (or at least not very logical) to purchase an insurance for something that you could not predict during your risk identification and assessment process, it is also very unlikely that you would have an insurance policy on “stand by” for such event.
In such case, it is safe to say that management reserves is the closest you’re ever going to get to an insurance against unknown unknowns. Needless to say that as a project manager, you would like to avoid asking use management reserves in your project.
Purchasing insurance is a way to minimize financial lost in your project, and a great tool in the arsenal of any project manager, if used wisely.
Project managers, regardless of industry and nature of the project, must always keep in mind that insurance does not take them off the hook in terms of identifying risk triggers, and actively working to reduce the risk of activating them.
For more project management articles read my post series: Obtaining a PMP certificate practical guide and study notes.