A family decides to purchase a life insurance policy on the primary wage earner so that the insurer will pay a death benefit if that person dies prematurely. This is best described as which risk management technique?
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Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
Insurance is the classic example of risk transfer: the financial burden of a possible loss is shifted from the individual or family to the insurer in exchange for a premium. By paying a relatively small, certain premium, the family is protected against a large, uncertain financial loss, and the insurer assumes the economic consequences of the wage earner's premature death. Risk avoidance means eliminating the exposure entirely, such as never flying. Risk retention means keeping the risk and paying losses out of pocket, and risk reduction means lowering the likelihood or severity of a loss without shifting it to another party.
Why the other options are wrong
- B) Avoiding the risk would mean removing the loss exposure itself, such as not having a wage earner depend on income; buying insurance keeps the exposure but shifts its financial consequences.
- C) Retention occurs when the insured keeps the risk and self-funds any losses, with no insurer involved in absorbing the financial shock. Retention may be a deliberate choice for small losses, but for a catastrophic premature death it leaves the family bearing the entire financial burden.
- D) Reduction lowers loss frequency or severity through measures such as safety devices or lifestyle changes; insurance instead shifts the financial consequences of the loss to an insurer. A family may practice reduction by living healthfully, but only transfer through insurance protects against the full economic loss of an untimely death.
Memory hook
Buy a policy, shift the risk: insurance is transfer, plain and simple. The insurer carries the bag now.