Risk Retention - When Risk Is Kept Instead of Transferred
Within the insurance industry, there are numerous strategies agencies can undertake to manage potential losses. One of these is risk retention, a concept that sits at the heart of risk management.
Remember the old saying, “sometimes you have to hold your risks close”? Okay, that might not be the exact saying, but for businesses using risk retention, it fits quite well. Risk retention involves absorbing potential losses rather than transferring them to an insurance company.
TL;DR
- Risk retention is the choice to take on potential losses rather than passing them on to an insurer.
- It’s key in minimizing costs, managing uninsurable risks, and creating industry-specific coverage in the insurance field.
- Mistakes: Misunderstanding risk tolerance and insurance policy limits can lead to too much, or too little, risk being retained.
- A quick win: Agencies can help clients understand their risk tolerance and guide them to decide what level of risk they can manage internally.
What Is Risk Retention in Insurance?
Plain-language definition: Risk retention is like choosing to wear a bicycle helmet rather than trusting luck to avoid an accident. It’s a way for businesses to take responsibility for certain risks and potential losses instead of buying insurance to cover them.
Technical definition: Risk retention is a risk mitigation strategy where exposure to potential losses remain with the organization instead of laying off to an insurance company. It is commonly utilized when insurance coverage is unavailable, too expensive, or when a business believes it can manage the risk better internally. It can take on the form of natural retention (unplanned) or planned retention (deductibles, self-insured retentions, self-insurance).
Key Related Terms to Know
- Risk Retention Group (RRG): A liability insurance company owned by its members, formed under the Liability Risk Retention Act (LRRA) of 1986.
- Self-Insurance: When a business sets risk reserves for potential losses instead of purchasing an insurance policy.
- Deductible: An amount a policyholder must pay before insurance coverage kicks in for a claim.
- Risk Management Strategy: A plan devised to handle risk, encompassing risk assessment and risk control techniques among others.
- Liability insurance: Coverage that provides protection against claims resulting from injuries and damage to people or property.
Common Questions About Risk Retention
What does risk retention mean?
Risk retention involves businesses taking on the responsibility for handling certain risks rather than transferring those risks to an insurance company. It often comes in the form of deductibles or self-insurance. For instance, a business might decide to retain risk related to minor, predictable losses because paying insurance premiums exceeds the cost of absorbing the losses internally.
What is a Risk Retention Group (RRG)?
An RRG is a group liability insurance company owned by its members, formed under the Liability Risk Retention Act of 1986. They are exempt from many state licensing requirements and are able to offer insurance products across state lines.
Are there different types of Risk Retention?
Yes, there’s horizontal risk retention and vertical risk retention. Horizontal risk retention involves establishing a threshold or limit per loss event, like an insurance deductible. Vertical risk retention, on the other hand, sets a cumulative limit for all losses within a specific period, like an annual cap on claims payouts.
How does Risk Retention fit into a broader Risk Management Framework?
Risk retention is one element within a comprehensive risk management framework. Other components include risk identification, risk assessment, risk control, and risk monitoring, which all play distinct roles in determining the best course of action – to prevent, mitigate, share, or accept each risk.
Business Income Worksheet vs. Business Interruption Worksheet
In traditional insurance, the insurer assumes the risk from the policyholder in exchange for an insurance premium. In risk retention, however, the business assumes the responsibility of absorbing the losses.
Comparison Area | Risk Retention | Traditional Insurance
|
Primary use case | For predictable, easily quantifiable losses | For catastrophic, large, less predictable losses |
Coverage / concept type | Part of risk management strategy | Risk transfer product |
Typical exclusions | None | Subject to policy exclusions and conditions |
Who is most affected by errors | The business retaining the risk | Both the insurer and insured |
Common mistakes | Misestimating risk tolerance and financial capacity to absorb losses | Misunderstanding policy limits, exclusions, and coverages |
Real Claim Examples Involving Risk Retention
Scenario 1: A manufacturing firm with a high deductible workers’ compensation policy experienced a rash of small, but frequent, workplace injuries. The firm’s decision to retain this risk allowed them to manage these predictable losses and maintain control over the care and claims management process.
Scenario 2: A risk retention group made up of doctors was able to provide specialized malpractice liability insurance to its members. The RRG’s policies provided coverage that was specifically tailored to the unique risks doctors face, something traditional insurance companies might not offer.
Scenario 3: A logistics company decided to retain the risk of minor vehicle damage and theft. Over time, their diligent loss control measures and a risk monitoring system helped reduce vehicle-related incidents, thereby justifying their decision to retain these risks.
Limitations and Common Mistakes
- Misestimating risk tolerance can lead to over-exposure to potential losses.
- Misunderstanding policy wordings can give a false sense of security about coverage.
- Inaccurate risk assessment may lead to retaining more risk than necessary.
- Absence of risk control and loss prevention measures may escalate retained losses.
How to Explain Risk Retention to Clients
Personal Lines client: “Think of risk retention as a backup savings account, it’s money you set aside to cover minor accidents or problems instead of using insurance.”
Small Business owner: “Imagine having control over handling certain risks your business faces. That’s risk retention—you decide which losses you can manage yourselves instead of paying an insurance company.”
CFO or Risk Manager: “Risk retention is a strategic choice. It’s your business deciding to absorb and manage particular losses, often those predictable and manageable, as a cost-saving measure rather than transferring all risks to an insurer.”