A business sets aside its own funds to pay for expected minor losses rather than buying insurance, while purchasing insurance only for catastrophic risks. Which two risk management techniques is the business using?
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Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
The risk management techniques are avoidance, retention, sharing, reduction, and transfer. Retaining small, predictable losses through an internal reserve fund, and transferring large, potentially catastrophic losses to an insurer, is a common strategy: the insured keeps risks it can afford and transfers those it cannot. Insurance is a form of risk transfer because the insurer assumes the financial burden of covered losses. This mix is efficient because catastrophic losses would otherwise be unaffordable, while routine losses are cheaper to absorb internally than to insure.
Why the other options are wrong
- B) Avoidance means not engaging in the activity at all; setting aside funds is retention, not avoidance, and does not match the scenario.
- C) Sharing spreads a loss among many parties and reduction means loss-control measures; neither describes an internal reserve plus insurance.
- D) This reverses the correct strategy: small losses are typically retained and large losses transferred, not the other way around.
Memory hook
Keep the nickels you can pay, transfer the elephants you cannot. Retain small, transfer big.