Property and Casualty Insurance Practice Exam

In managing risk, which action involves taking on financial responsibility?

1. Risk retention

2. Risk transfer

3. Risk avoidance

4. Risk control

The correct answer is: Risk retention

Risk retention refers to the decision to accept the potential costs associated with a risk rather than transferring that risk to another party, such as an insurance company. When an individual or organization decides to retain risk, they are essentially acknowledging that they will handle any resulting financial consequences themselves. This approach can be strategic, especially when the costs of insurance or other risk management techniques may exceed the potential losses that could occur from the risk itself. For example, a business might choose to retain the risk of minor damage to its property because the likelihood of an event occurring and the cost to repair the damage may be relatively low compared to the expense of transferring that risk through insurance. In this context, retaining risk allows the entity to invest the resources that would have gone to insurance premiums into other areas of their operations. The other options represent different strategies in managing risk. Risk transfer involves shifting the financial burden to another party, such as through insurance. Risk avoidance entails eliminating the risk altogether, and risk control focuses on implementing measures to minimize the impact of the risk or its likelihood of occurring. Each of these strategies has its own advantages and may be used in conjunction with risk retention, but they do not define the act of taking on financial responsibility for potential losses.