CFP

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.



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