What type of risk financing is used when a person transfers responsibility for damages through a liability policy?

The correct choice is based on the concept of transferring risk to another party, which is a fundamental aspect of risk financing. When an individual or organization purchases a liability policy, they are effectively shifting the financial responsibility for potential damages or claims to the insurance company. This transfer of risk means that the insurer will handle claims and compensation costs that arise from covered events, minimizing the financial burden on the insured party.

In risk management, this mechanism is known as risk transfer, as it involves legally transferring the potential costs associated with certain risks. Liability insurance serves as a classic example where the policyholder pays a premium in exchange for coverage that protects them from claims made by third parties. This allows the insured to manage their financial exposure effectively, knowing that they have an insurer backing them in case of a liability event.

Other forms of risk financing, such as active retention, passive retention, and self-insurance, involve retaining the risk rather than transferring it. Active retention occurs when organizations deliberately decide to assume the risk by setting aside funds to cover potential losses. Passive retention happens when risks are retained without any plan for coverage, often due to oversight or lack of awareness. Self-insurance involves entities creating a fund to pay for their own claims, which still differs from the