CHAPTER 4
Risk-Handling Techniques:
Loss Control, Risk Transfer,
and Loss Financing
I. SUGGESTED CLASSROOM TIME: 60–75 MINUTES
II. CHAPTER OVERVIEW
This chapter introduces the risk-handling techniques of loss control, risk transfer, and loss
financing. These techniques are typically used with pure risk exposures and may have
some application with speculative risk exposures. The choice of risk-handling technique is
made by an entity after a careful consideration of several important factors.
There is a detailed explanation of the many aspects of loss control, ranging from
III. LECTURE OUTLINE
A. Introduction: The choice of risk-handling techniques is a function of: 1) frequency and
severity of loss; 2) the size of the firm or economic entity; and 3) the supply of
insurance (insurance markets are discussed in Chapter 9).
B. Loss or Risk Control (All techniques designed to reduce frequency or severity of loss)
1. Loss prevention (frequency)
24 Chapter 4/Risk-Handling Techniques: Loss Control, Risk Transfer, and Loss Financing
C. Risk Transfer
1. Risk-bearing financial institutions, e.g., Chicago Board of Trade
D. Loss Financing
1. Insurance
2. Insurance with deductibles (and self-insured retentions [SIRs])
E. Choosing an Appropriate Risk-Handling Technique Based on Loss Frequency and
Severity
1. Low frequency, low severity—RETAIN
VI. ANSWERS TO REVIEW QUESTIONS
1. How is loss prevention different from loss reduction? Give some examples
of each. Loss prevention reduces the frequency of loss or the number of losses that
2. Describe the conditions in which avoidance is an appropriate risk–
handling technique. Avoidance is an appropriate risk-handling technique for high
3. What is OSHA, and how does it relate to a firm’s risk-management
program? OSHA, the Occupational Safety and Health Organization, imposes a
Chapter 4/Risk-Handling Techniques: Loss Control, Risk Transfer, and Loss Financing 25
4. Describe how firms use contractual transfer methods to handle risk.
Provide two examples. Contractual transfers of risk involve trying to have some
5. Describe how firms can use limited liability as a means to protect
themselves from risk. Firms organize as corporations or as limited-liability
6. Describe the advantages and disadvantages of using insurance as a loss–
financing technique. The principal advantages of insurance are the certain costs,
7. Describe the role of deductibles in insurance contracts. Deductibles are a
form of loss retention. They can reduce premium, and in general, the larger the
8. How does self-insurance differ from risk assumption as an internal loss–
financing technique? Risk assumption means that the entity has decided not to
9. What are the potential advantages (and disadvantages) of a self-insurance
program? The greatest advantage of a self-insurance program is that some part, but
10. Describe the benefits associated with using captive insurers as a loss–
financing technique. Captive insurers are dedicated risk financing units within
26 Chapter 4/Risk-Handling Techniques: Loss Control, Risk Transfer, and Loss Financing
11. Describe how loss frequency and loss severity affect a firm’s choice of risk-
handling techniques. These are key factors in choosing risk-handling techniques.
V. ANSWERS TO OBJECTIVE QUESTIONS
1. A pharmaceutical firm recalls a popular drug after a study reveals that it causes deadly
side effects and later announces that it will no longer sell the drug. This decision is an
example of which of the following?
2. Installing airbags in automobiles is an example of which of the following?
3. ABC Mills agrees to assume the financial responsibility for losses caused by a local
railroad as part of an agreement to build a railroad sidetrack next to ABC’s silos. This
exemplifies which of the following?
4. Insurance is frequently used as a risk-handling technique for ____________ losses.
a. high frequency, high severity
5. Which of the following statements regarding deductibles in insurance policies is
correct?
I. Deductibles decrease moral hazard behavior by policyholders.
II. Increasing the deductible in an insurance policy can help decrease the policy
premium.
Chapter 4/Risk-Handling Techniques: Loss Control, Risk Transfer, and Loss Financing 27
6. An insurance policy with a deductible is an example of which of the following?
7. Self-insurance is frequently used as a risk-handling technique for ____________
losses.
8. Cellar-Dwellers, Inc. is a construction firm that specializes in building residential
basements. The firm estimates that thieves steal 1,000 cement blocks from the firm’s
work sites each year, which it pays for out of its current cash accounts. This financing
arrangement exemplifies which of the following?
9. Captive insurers
I. often are used to finance the self-insured losses of a large corporation.
10. The federal law that promotes a safe working environment for workers is
VI. IDEAS FOR INSTRUCTORS AND TEACHING METHODS
1. Look in Business Insurance or National Underwriter for articles about captive
28 Chapter 4/Risk-Handling Techniques: Loss Control, Risk Transfer, and Loss Financing
2. Ask the students what they think of informal risk transfer attempts, such as the “We
Are Not Responsible for Damage to Your Car” signs in parking lots. Do they believe
they are effective?