Chapter 5 Answers Multiple Choice (Questions 35-56)

Risk Management Concepts and Techniques

35. Choice (c) is the correct answer. Objective risk is probable variation of actual from expected
losses divided by expected losses. (45 - 35)/30 = 10/30 = 33.3%. The loss experience information
is not relevant here (IIA Standard 2120 Risk Management).
36. Choice (b) is the correct answer. The risk-management process involves identifying risks,
evaluating risks, selecting risk-management techniques, and implementing and reviewing
decisions (IIA Standard 2120 Risk Management).
37. Choice (a) is the correct answer. Risk means uncertainty. Risk regarding the possibility of
loss can be especially problematic. It is when there is uncertainty about the occurrence of a loss
that risk becomes an important problem (IIA Glossary and IIA Standard 2120 Risk
Management).
38. Choice (c) is the correct answer. Risks can be classified into three types: static versus
dynamic, subjective versus objective, and pure versus speculative (IIA Glossary and IIA
Standard 2120 Risk Management).
39. Choice (c) is the correct answer. Flowcharts, contract analysis, statistical analysis, on-site
inspections, and others are used to identify risks. Financial engineering is used to reduce
financial risk. This includes options, calls, and puts (IIA Standard 2120 Risk Management).
40. Choice (a) is the correct answer. This question is based on probability calculation, which
ranges from 0 to 1. The probability of an employee being injured is defined as the chance of
injury in terms of number of injuries divided by the number of employees. 5/30 = 0.1667. (IIA
Standard 2120 Risk Management).
41. Choice (c) is the correct answer. The expected value is defined as the probability of loss
multiplied by the amount of loss. 0.06 x $700 + 0.07 x $3,000 + 0.02 x $2,500 + 0.13 x $950 +
0.13 x $1,000 = $42 + $210 + $50 + $123.5 + $130 = $555.5. (IIA Standard 2120 Risk
Management).
42. Choice (c) is the correct answer. Common methods of loss control include reducing the
probability of losses or decreasing the cost of losses that do occur (i.e., cost reduction).
Probability of losses is related to frequency and severity (IIA Glossary and IIA Standard 2120
Risk Management).
43. Choice (c) is the correct answer. Self-insurance by a firm is possible and feasible when it has
accurate records or has access to satisfactory statistics to enable it to make good estimate of
expected losses. The general financial condition of the firm should be satisfactory and the firms

management must be willing and able to deal with large and unusual losses (IIA Standard 2120
Risk Management).
44. Choice (b) is the correct answer. The most widely used form of risk transfer is insurance (IIA
Glossary and IIA Standard 2120 Risk Management).
45. Choice (d) is the correct answer. Risk transfer applies to risks that have a low expected
frequency but a high potential severity. As a rule, risk retention is optimal for losses that have a
low expected frequency and low potential severity (choice a). When losses have both high
expected frequency and high potential severity (choice c), it is likely that risk transfer, risk
retention, and loss control all will need to be used in varying degrees (IIA Glossary and IIA
Standard 2120 Risk Management).
46. Choice (c) is the correct answer. Incorporating an organization is an example of risk transfer
(IIA Standard 2120 Risk Management). The other three choices are examples of risk retention.
47. Choice (a) is the correct answer. The following conditions are suggestive of the types of
situations where self-insurance by a business is both possible and feasible: (1) The firm should
have a sufficient number of objects so situated that they are not subject to simultaneous
destruction; (2) The firm must have accurate records or have access to satisfactory statistics to
enable it to make good estimates of expected losses; (3) The firm must make arrangements for
administering the plan and managing the self-insurance fund; and (4) The general financial
condition of the firm should be satisfactory, and the firms management must be willing and able
to deal with large and unusual losses (IIA Standard 2120 Risk Management).
48. Choice (a) is the correct answer. Captive insurers combine risk retention and risk transfer.
Risk mapping and risk profiling are the same (IIA Glossary and IIA Standard 2120 Risk
Management).
49. Choice (b) is the correct answer. Risk retention can be planned or unplanned, funded or
unfunded. Self-insurance and reserve funds are examples of risk retention (IIA Standard 2120
Risk Management).
50. Choice (c) is the correct answer. The steps for selecting among available risk-management
techniques for a given situation may be summarized as follows: (1) avoid risks if possible, (2)
implement appropriate loss control measures, and (3) select the optimal mix of risk retention and
risk transfer (IIA Glossary and IIA Standard 2120 Risk Management).
51. Choice (c) is the correct answer. Risk transfer methods include diversification, hedging, and
hold-harmless agreements. Self-insurance is an example of risk retention. (IIA Standard 2120
Risk Management).
52. Choice (c) is the correct answer. Both capital budgeting and statistical procedures may be
used in selecting an appropriate retention level (a mix consisting of risk retention and transfer),

with insurance purchased for losses in excess of that level (IIA Standard 2120 Risk
Management).
53. Choice (d) is the correct answer. Because objective and subjective risks are often both
present in the same situation, some consideration must also be given to managing subjective risk.
In one sense, the techniques applied to objective risk should also affect subjective risk. If risks
have been systematically identified and analyzed, and if decisions have been made regarding the
appropriate methods for dealing with those risks, then in most cases subjective risk can be
expected to decrease. In addition, two other specific ways to deal with the existence of subjective
risk are obtaining more information and group discussion (IIA Standard 2120 Risk
Management).
54. Choice (b) is the correct answer. What constitutes high and low loss frequency and
severity must be established on an individual basis. What is low loss severity for a multimilliondollar company may be quite high for a small firm or an individual. In this regard, concepts such
as total assets, net worth, and expected future income all are relevant (IIA Glossary and IIA
Standard 2120 Risk Management).
55. Choice (d) is the correct answer. Because in many situations both risk retention and risk
transfer will be used in varying degrees, it is important to determine the appropriate mix of these
two risk-management techniques. Both capital budgeting methods and statistical procedures may
be used in selecting an appropriate risk retention level, with insurance purchased for losses in
excess of that level (IIA Glossary and IIA Standard 2120 Risk Management).
56. Choice (b) is the correct answer. The following conditions are suggestive of the types of
situations where self-insurance by a business is both possible and feasible: (1) The firm should
have a sufficient number of objects so situated that they are not subject to simultaneous
destruction; (2) The firm must have accurate records or have access to satisfactory statistics to
enable it to make good estimates of expected losses; (3) The firm must make arrangements for
administering the plan and managing the self-insurance fund; and (4) The general financial
condition of the firm should be satisfactory, and the firms management must be willing and able
to deal with large and unusual losses (IIA Standard 2120 Risk Management).