Definition - What does Risk Retention mean?
Risk retention is an individual or organization’s decision to take responsibility for a particular risk it faces, as opposed to transferring the risk over to an insurance company by purchasing insurance. That means the individual or organization has chosen to pay for any losses out of pocket rather than purchasing insurance as a means of transferring the financial burden of a loss to a 3rd party.
Companies often retain risks when they believe that the cost of doing so is less than the cost of fully or partially insuring against it. Shoplifting losses are one example of risks that many companies choose to retain instead of purchasing or claiming on their crime insurance policy.
Another reason companies may choose to retain a risk is when it is not insurable or falls below their policy deductible. In this case, it is referred to as “forced retention”.
Insurance companies also have to make a decision about which risks to retain. Risks they choose not to retain are transferred out via a reinsurance policy.
Insuranceopedia explains Risk Retention
When a company chooses or is forced to retain a certain risk, they will be responsible for paying any losses from that risk out of pocket. For this reason, it is important for companies to make sure that they can properly afford to pay for potential losses before they make the decision to retain particular risks.
Oftentimes, the money can come from their current cash flows, from reserve funds set aside for these types of losses, or if they are frequent and predictable enough, they can be put into the monthly budget.
Risk retention can either be done voluntarily or be forced.
The decision to retain a risk voluntarily usually comes down to an economic calculation. If the losses happen often enough to be budgeted for or if the premiums for insuring against this risk is too high, many companies will choose to voluntarily retain the risk. Large organizations such as railway operators or government bodies may also choose to forgo insurance and retain almost all of their risk because they are big enough to absorb potential losses. These types of organizations can save money by not purchasing insurance.
Other times, companies are forced to retain a risk or loss. This happens when the risk is either excluded from their coverage, uninsurable, or when the value of the loss is less than their policy deductible.
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