A wage earner buys life insurance so that, if death occurs prematurely, the financial burden on the family shifts to the insurance company. This is an example of which risk management technique?

Why A is correct

Transfer shifts the financial consequences of a potential loss to another party, the insurer, in exchange for a premium. When a person buys life insurance, the economic risk of premature death moves from the family to the insurance company. Avoidance means eliminating the exposure entirely; retention means absorbing the loss internally, as with a deductible; reduction lowers the frequency or severity of loss, such as installing safety equipment. Because life insurance substitutes a known, small premium for the risk of a large loss, it is the classic example of risk transfer.

Why the other options are wrong

• Avoidance means refusing to take on the exposure at all, for example by not engaging in the activity. Buying life insurance does not avoid death; it shifts the financial consequences of death to the insurer.
• Retention occurs when a person keeps the risk and pays any losses out of pocket, such as self-insuring a small exposure. Purchasing insurance is the opposite of retention because the risk is moved elsewhere.
• Reduction lowers the likelihood or severity of a loss through measures such as installing smoke alarms. Life insurance does not reduce the chance of death; it transfers the economic impact of death to the insurer.

Memory hook

Insurance trades a small premium for a big risk, so it is a transfer technique.