A group of small businesses contributes to a common fund from which any member's covered losses are paid. This arrangement illustrates risk:

Why A is correct

Risk sharing spreads the financial consequences of loss among a group of participants, each of whom contributes to a fund that pays the losses of any member. Insurance itself is a formalized system of risk sharing built on the law of large numbers: many exposures contribute premiums so that the few who suffer losses are paid. Because the losses are divided among the group, no single member bears the full financial burden alone. This is distinct from avoidance, which eliminates the activity creating the risk, from retention, which keeps losses with each individual, and from reduction, which lowers the frequency or severity of losses.

Why the other options are wrong

• D) Avoidance eliminates the activity that creates the risk. In this arrangement, no activity is being eliminated; losses are simply being pooled among members. Accordingly, this plausible-sounding answer is one that examiners expect candidates to eliminate.
• B) Retention means each participant bears its own losses individually. Pooling contributions so that members' losses are paid from a common fund is the opposite of individual retention. This statement does not survive the statutory analysis presented above and is therefore wrong.
• C) Reduction lowers the frequency or severity of losses before they occur. This arrangement spreads the cost of losses that still occur rather than reducing them. The correct answer follows from the controlling authority, which this option does not follow.

Memory hook

Sharing splits the bill across the group. Many pockets, one loss, nobody broken.