Risk spreading is a different form of risk management. Imagine that an oil supertanker has to be insured and the owner approaches one insurer. In the event of the tanker being ship- wrecked the damage caused by the resulting oil spill would be catastrophic – both to the environment and the insurance company, which would have to pay for the damage. In this instance the insurance company does not benefit from the law of large numbers – it is not insuring thousands of such tankers and therefore would find it difficult to balance the potential claims with the annual insurance premiums. As a consequence such insurers generally spread the potential cost among other insurers, and this is what is called risk spreading.
Risk spreading: spreads the risk of a venture
among multiple sub insurers.
The logic is similar to participating in an office Super-Bowl lottery. Most people are willing to risk the loss of $5 or $10, but very few would participate if the required bet were $100. The world’s major insurers – such as Lloyd’s of London has hundreds of syndicates who each take on a small proportion of a big risk. These syndicates may again choose to subdivide their share among others, until the big risk becomes widely spread. In this way it is possible to insure against almost any eventuality, no matter how large.
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