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Difficulty: HardMethods of Handling Risk

A large multinational university system decides to restructure how it handles workers' compensation claims for its thousands of employees. Instead of purchasing coverage through a standard commercial carrier, the university system forms and fully capitalizes a wholly owned subsidiary to act as a captive insurance company. Through this captive entity, the university sets aside its own corporate funds in dedicated reserve accounts to pay for employee injury claims directly as they occur. Which of the following methods of handling risk is the university system primarily utilizing through this arrangement?

  1. RetentionAnswer
  2. B
    Transfer
  3. C
    Sharing
  4. D
    Reduction

Answer

The university system is utilizing risk retention.
The correct answer is retention. Risk retention means assuming the financial responsibility for a loss. Although the university system set up a formal mechanism called a captive insurance company, it is a wholly owned subsidiary capitalized by the university's own funds. Because the university system is ultimately paying for its own losses out of its own reserves, it is retaining the risk.

Step-by-Step Solution

1
Analyze the financial flow described in the scenario.
The university is using its 'own corporate funds in dedicated reserve accounts' to pay for the claims.
Identifying who ultimately bears the financial burden is the key to distinguishing between risk handling methods.
2
Evaluate the role of the 'captive insurance company'.
Because the captive is a 'wholly owned subsidiary' of the university, the financial risk has not left the parent organization.
A common trap is assuming that the presence of any entity labeled 'insurance' automatically implies risk transfer.
3
Match the scenario to the STARR methods.
Assuming the financial responsibility for a loss, whether paid out of current cash flow or a formalized reserve fund (like a captive), defines the concept of retention.
Risk retention includes deliberate self-insurance strategies where the entity chooses to absorb the financial consequences of the risk.

Key Concept

Methods of Handling Risk (Retention vs. Transfer)
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Topics

Methods of Handling Risk

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