A risk valued at $650,000 with a 25% probability of occurrence; transferring risk would cost $150,000. What is recommended?

A risk valued at $650,000 with a 25% probability of occurrence; transferring risk would cost $150,000. What is recommended?

• A. Accept the risk
• B. Transfer the risk
• C. Mitigate the risk
• D. Don't engage with the risk

Answer: (B)

The key idea is to compare what it costs to transfer a risk with the expected cost of the risk if you keep it. Here, the risk has a potential impact of 650,000 with a 25% chance, so the expected loss if you retain it is 0.25 × 650,000 = 162,500. Transferring the risk costs 150,000. Since 150,000 is less than the 162,500 you’d expect to lose by keeping the risk, transferring reduces your expected cost by 12,500. Therefore, transferring the risk is the economically rational choice. Accepting the risk would leave you with the higher expected loss (162,500). Mitigation would require additional data on how much it costs to reduce either the probability or impact; without that, transferring is the better option given the numbers. Not engaging with the risk isn’t sensible here because you’d still face the expected loss.

The key idea is to compare what it costs to transfer a risk with the expected cost of the risk if you keep it. Here, the risk has a potential impact of 650,000 with a 25% chance, so the expected loss if you retain it is 0.25 × 650,000 = 162,500. Transferring the risk costs 150,000. Since 150,000 is less than the 162,500 you’d expect to lose by keeping the risk, transferring reduces your expected cost by 12,500. Therefore, transferring the risk is the economically rational choice.

Accepting the risk would leave you with the higher expected loss (162,500). Mitigation would require additional data on how much it costs to reduce either the probability or impact; without that, transferring is the better option given the numbers. Not engaging with the risk isn’t sensible here because you’d still face the expected loss.