Incorporation and Combination to Eliminate Risk By Sarah Martin At Isnare.com Ezine Articles

A central method of shifting risk is through incorporation. The corporation is a type of business organization which has a separate existence from its owners. Ownership is not direct, as in the partnership or sole proprietorship, but is through the holding of shares of stock. The corporation has been defined as "an ingenious device for obtaining individual profit without individual responsibility." The corporation has unlimited liability to its creditors to the extent of its assets.

The stockholders, however, if their shares of stock are fully paid for, have no liability beyond the extent of their investment in the stock. Creditors of the corporation have no recourse against the personal assets of the shareholders. The corporation makes it unnecessary for an investor to place his entire personal estate at risk in order to invest part of it in one enterprise. If the corporation had not been developed, it seems doubtful that large-scale enterprise as we know it today would have been possible.

It is often easier to find 1,000 men willing to risk $500 each in an enterprise than it is to find one man willing to risk $500,000. The investor is willing to share the risk by shifting part of it to others. Included in those who bear the risk of corporate enterprise are not only the owners, whose liability is limited, but also the creditors, who stand to lose if the corporation cannot survive.

Risk May Be Reduced by Combination

There are various methods of reducing risks through combination. In the previous examples, methods have been explained that can be used to assume risks or to shift them. None of these methods, however, reduces risk. They merely try to cushion the blow or else to see that the blow hits someone else. The methods to be discussed in this section actually succeed in making quantities of risk disappear. By combination, and the proper protection (such as homeowners insurance, http://cheap-insurance-rates.com/home/birmingham.cfm), risks can actually be reduced.

One method of reducing risk by combination is through large-scale operation. A man who has erected his own telephone pole for intrablock communication will be out of the telephone business if lightning should strike this pole. His risk is great. But the American Telephone and Telegraph Company, with its millions of poles, does not have this worry. Because of its large-scale operations, it can predict rather accurately the number of poles that it will lose each year—through lightning, termites, and motorists. Its risk has been reduced through its growth.

A second method of handling risk by combination is insurance. This is the method with which we are most concerned. The home owner knows that some houses will burn. He is uncertain, however, as to whether or not his house will burn. He is also uncertain as to the loss he will suffer if fire does break out. He cannot set up a reserve to meet these losses, since that method, as we have seen, does not work when there is only one piece of property involved.

He might, of course, buy 10,000 other houses so that his loss would be a little more predictable; but most home owners are not in a position to make this outlay. He can achieve the same end, however, by combining his risk with the risks of millions of other home owners through the services of an insurance company. This is why there are so many opportunities to get an instant homeowners insurance quote (http://cheap-insurance-rates.com/home/) from so many competing insurance companies.

When risks are combined in this way, losses become more predictable; and the risk is reduced. Each member of the group then knows what his share of the loss will be. He can budget for this small fixed amount, knowing that this charge is the most that a fire can cost him. Property losses resulting from a fire will be paid from the group funds.

The situation in life insurance is comparable: "Nothing more certain than death; nothing more uncertain than the hour of death." There is always the possibility that even the healthiest man may die this year, but whether the possibility will become a reality in a particular case is unknown. By combining the premature-death risk of one man with those of millions of others, the uncertainty can be eliminated. Each individual's share can be determined exactly and spread equitably among the members of the group.

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