Principles of Risk and Insurance - Responding to Risks

RESPONSE TO RISK

Risk Control

Risk Avoidance
A risk may be avoided if the individual refuses to accept risk by not engaging in an action that creates a risk (removal of the peril).
Consider the following risk avoidance instances:

  • Taking the bus rather than buying a car
  • Renting a home rather than buying it
  • Not buying an office building without a sprinkler system

Risk Diversification
Risk diversification, also known as risk sharing, is a method of reducing your total exposure to risk by sharing the responsibility with another party.
Consider the following risk diversification strategies:
  • Forming a limited partnership for your business
  • Hedging contracts
  • Health insurance with deductibles and co-payments

Risk Reduction
Risk reduction is the process of diminishing risk through the implementation of loss prevention methods or implementing safety features or improvements.
Consider the following risk reduction techniques:
  • Mounting smoke detectors in your building
  • Installing hurricane shutters on your home
  • Put a burglary system on your vehicle

Risk Financing
Risk Retention
Risk retention is the act of accepting risk and confronting it if and when it occurs. In this process, no action is taken to avoid, transfer, or reduce risk.
Consider the following risk retention actions:
  • Self-insurance
  • Coinsurance in various insurance policies
  • Utilizing deductibles in insurance contracts

Risk Transfer
Risk transfer is the practice of shifting risk responsibility either through an individual or an insurance contract. The most effective way to handle risk is to transfer it so that the loss is consumed by another party.
Consider the following risk transfer solutions:
  • Purchasing an insurance policy
  • Obtaining high protection limits on your auto policy
  • Reassign the risk to another individual

Practice Question:
Of the following methods of handling risk, which technique best describes "wearing seat belts" when driving your motor vehicle?

A. Risk Avoidance
B. Risk Transfer
C. Risk Retention
D. Risk Reduction

Answer: D
Risk reduction is the practice of reducing or eliminating risk by implementing safety features, such as using a seat belt.

Practice Question:
For risks that involve high loss severity and low loss frequency, the most suitable procedure is?

A. Risk Sharing
B. Risk Reduction
C. Risk Avoidance
D. Risk Transfer

Answer: D
Risk Transfer is the best answer. Transferring risk to an insurance policy is the most effective method of preparing for high loss severity and low loss frequency. High loss and high frequency risks should be avoided. The Legal Aspects of Insurance
Related Articles
  1. Investing Basics

    Calculating the Margin of Safety

    Buying below the margin of safety minimizes the risk to the investor.
  2. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  3. Mutual Funds & ETFs

    ETF Analysis: Guggenheim Enhanced Short Dur

    Find out about the Guggenheim Enhanced Short Duration ETF, and learn detailed information about this fund that focuses on fixed-income securities.
  4. Mutual Funds & ETFs

    ETF Analysis: iShares Morningstar Small-Cap Value

    Find out about the Shares Morningstar Small-Cap Value ETF, and learn detailed information about this exchange-traded fund that focuses on small-cap equities.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI KLD 400 Social

    Find out about the iShares MSCI KLD 400 Social exchange-traded fund, and learn detailed information about its characteristics, suitability and recommendations.
  6. Mutual Funds & ETFs

    ETF Analysis: Guggenheim BulletShrs 2018 HY CorpBd

    Find out about the Guggenheim BulletShares 2018 High Yield Corporate Bond ETF, and get information about this ETF that focuses on high-yield corporate bonds.
  7. Mutual Funds & ETFs

    ETF Analysis: PowerShares DWA SmallCap Momentum

    Find out about the PowerShares DWA SmallCap Momentum Portfolio ETF, and explore detailed analysis the fund's characteristics, suitability and recommendations.
  8. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  9. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  10. Mutual Funds & ETFs

    ETF Analysis: Vanguard Total World Stock

    Learn about the Vanguard Total World Stock exchange-traded fund, which invests in stocks located in numerous countries with a high level of diversification.
RELATED TERMS
  1. Net Line

    The amount of risk that an insurance company retains after subtracting ...
  2. Political Risk Insurance

    Coverage that provides financial protection to investors, financial ...
  3. Maximum Drawdown (MDD)

    The maximum loss from a peak to a trough of a portfolio, before ...
  4. Gross Exposure

    The absolute level of a fund's investments.
  5. Priori Loss Estimates

    A technique used by insurance companies to calculate loss reserves.
  6. Value Of Risk (VOR)

    The financial benefit that a risk-taking activity will bring ...
RELATED FAQS
  1. Is my IRA/Roth IRA FDIC-Insured?

    The Federal Deposit Insurance Corporation, or FDIC, is a government-run agency that provides protection against losses if ... Read Full Answer >>
  2. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  3. What are common delta hedging strategies?

    The term delta refers to the change in price of an underlying stock or exchange-traded fund (ETF) as compared to the corresponding ... Read Full Answer >>
  4. How does being overweight in a particular sector increase risk to a portfolio?

    An investor who is overweight in a particular sector risks a loss in value for the portfolio if there is a downturn in that ... Read Full Answer >>
  5. What are the primary risks an investor should consider when investing in the retail ...

    The retail sector consists of companies operating in multiple industries such as specialty retail, general retail, food and ... Read Full Answer >>
  6. What risks do I face when investing in the insurance sector?

    Like all equity investments, insurance companies present investors with market risk. Insurance companies, like banks, also ... Read Full Answer >>
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!