A 40-year-old buys a term life policy instead of setting money aside, because her family could not absorb the financial loss of her death. Which risk management technique is she using?
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Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
Insurance is the classic risk transfer mechanism. By paying a relatively small, certain premium, the insured shifts the uncertain financial burden of an early death to the insurer, which pools many similar risks. Setting money aside informally would be retention, since the family would still bear any loss. Avoidance means not engaging in the activity that creates the risk, and reduction means loss-control measures that lower the probability or severity of loss. The purchase of a term policy therefore represents transfer, and the contract functions properly because the risk is a pure risk — only loss, never gain.
Why the other options are wrong
- B) Retention is self-funding the risk, as when a person saves money instead of buying coverage; the insured here shifted the burden to an insurer, which is transfer.
- C) Avoidance would mean avoiding the exposure entirely, such as refusing to fly; buying insurance does not avoid the risk, it finances the possible loss.
- D) Reduction involves loss control such as smoke detectors or seat belts that make the loss less likely; it does not describe shifting the financial risk to an insurer.
Memory hook
A policy hands the loss to the insurer — that is transfer, not self-funding.