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Question

Difficulty: HardMethods of Handling Risk

An IT consulting firm operates a fleet of 50 company vehicles. After analyzing insurance costs, the risk manager determines that the premiums for physical damage coverage (comprehensive and collision) are disproportionately high given the aging fleet's actual cash value. The firm decides to drop all physical damage coverage. Instead, they deposit $30,000 annually into a dedicated, liquid reserve account to cover any future collision repairs or vehicle replacements, while continuing to purchase commercial auto liability insurance for third-party claims. Regarding the pure risk of physical damage to their vehicles, which method of handling risk has the firm primarily implemented?

  1. Risk retention, because the firm has consciously chosen to assume the financial responsibility for physical damage losses rather than purchasing insurance.Answer
  2. B
    Risk reduction, because establishing a dedicated $30,000 reserve account decreases the physical severity of any future vehicle collisions.
  3. C
    Risk avoidance, because canceling the physical damage policies completely eliminates the peril of collision from the firm's daily operations.
  4. D
    Risk sharing, because the firm is taking a speculative risk that their $30,000 annual reserve will be more profitable than paying traditional insurance premiums.

Answer

Risk retention, because the firm has consciously chosen to assume the financial responsibility for physical damage losses rather than purchasing insurance.
The correct answer accurately describes risk retention, often referred to as self-insurance in a commercial context. By choosing to drop their physical damage coverage and instead setting aside a dedicated reserve fund to pay for their own property losses, the firm has actively chosen to retain the financial consequences of that specific risk.

Step-by-Step Solution

1
Analyze the action taken by the IT consulting firm regarding the specific physical damage risk.
The firm canceled its physical damage insurance and created a $30,000 reserve account to pay for future damages directly.
Identifying the specific action and the specific risk it addresses is necessary to classify the risk handling method.
2
Evaluate whether the physical risk was eliminated, minimized, transferred, or kept.
The physical risk of collision was not eliminated (vehicles are still driven) or transferred (no insurance company is paying for it). The firm kept the risk and set aside its own money to fund potential losses.
This process of elimination separates risk avoidance, transfer, and reduction from risk retention.
3
Match the firm's action to the STARR acronym methods.
Setting aside funds to cover one's own expected losses is the definition of self-insurance, which is a textbook form of risk retention.
This confirms the correct technical terminology for the firm's risk management decision.

Key Concept

Risk Retention and Self-Insurance
Estimated Time:1m 30s
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Topics

Methods of Handling Risk

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