Risk Retention
What Does Risk Retention Mean?
Risk retention occurs when an individual or organization decides to take responsibility for a particular risk instead of transferring it to an insurance company by purchasing coverage. This means they opt to pay for any losses out of pocket rather than relying on insurance to bear the financial burden.
Companies often retain risks when they determine that the cost of retention is lower than the cost of fully or partially insuring against the risk. For example, many businesses choose to retain the risk of shoplifting losses rather than purchasing or claiming on a crime insurance policy.
Risk retention can also occur when a risk is uninsurable or falls below the policy deductible. In such cases, it is referred to as “forced retention.”
Insurance companies also engage in risk retention, deciding which risks to assume directly. Those they choose not to retain are transferred to a reinsurer through a reinsurance policy.
Insuranceopedia Explains Risk Retention
When a company chooses or is forced to retain a certain risk, it becomes responsible for covering any losses associated with that risk out of pocket. Therefore, it is crucial for companies to ensure they can afford potential losses before deciding to retain specific risks.
The funds for covering retained risks may come from current cash flows, reserve funds allocated for such losses, or, if the losses are frequent and predictable, they can be incorporated into the monthly budget.
Risk retention can be either voluntary or forced:
- Voluntary Risk Retention:
Companies often make a calculated economic decision to retain risks voluntarily. If the losses are frequent enough to be budgeted for, or if insurance premiums for covering the risk are prohibitively high, retaining the risk may be more cost-effective. Large organizations, such as railway operators or government bodies, may forgo insurance entirely and retain almost all their risks because they have the financial capacity to absorb potential losses. By avoiding insurance premiums, these organizations can save significant amounts of money. - Forced Risk Retention:
In some cases, companies are compelled to retain a risk. This occurs when the risk is excluded from their insurance coverage, deemed uninsurable, or when the loss amount falls below their policy deductible. In such situations, the company has no choice but to assume the financial responsibility for these risks.
