Risk Retention in Insurance: Meaning and Types

After reading this article you will learn about the meaning and types of risk retention.

Meaning of Risk Retention:

It is nothing than presuming that we are going to incur certain losses on a particular issue but at the same time are not willing to transfer such risks to another party.

For example in an individual case a persons decides to bear all the losses caused to his property by himself and never cares to get his property insured means all the risk shall be retrained by that particular individual and in case of any eventuality he shall only be paying from his own pocket for the losses caused to his property.

And in case of a corporation or a company engaged in construction works, if it is decided to pay to the accidental expenses of its employees instead of entering into an agreement with any insurance company to compensate the expenses.

In such a case the corporation or the company concerned have decided to bear the cost themselves instead of transferring it to any insurance company and are also willing to retain the loss.( IN SHORT THE LOSSES WHICH ARE BORN BY ANY INDIVIDUAL OR A COMPANY OUT OF HIS/IT OWN POCKET IS CALLED RETENTION OF RISK).

Types of Risk Retention:

Risk of any type is always an action of uncertainty. Either when should be willing to accept such risk knowingly and voluntary. When such a decision is taken the risk is known as voluntary risk with considered and conscious decision where certain level of risk is retained willingly rather than transferring it to another party (Say insurance company) at a cost (say premium). Such type of risks are sometimes imposed by the insurers also up to certain level.

A situation also arises when some risk occurs due lack of pre identification of the risk. Such type of risk are known as non-voluntary risk because these occur due failure of identification of risk before hand. In such circumstances the risk has to be retained and met out of within own sources on the happening of eventuality of the occurrence of the event.

In other words the retention of risk means one is liable to bear the losses himself up to the amount retained. May be it is done to keep the cost of insurance premium at the minimum level.

In case of companies the risk retention is either by not having insurance that covers a particular eventuality or in the form of deductibles. They may also not be having insurance for certain occurrence. But generally most of the companies do maintain a contingency fund with a big role of retaining the risks.

Basically the more risk a company retains, the more needs to be set aside in the contingency funds. But it is not the solution of covering the risks. At last most of the companies by themselves or through the services of any consultant take the shelter of one or the other insurance company to transfer their risk. However the quantum of risk can be decided to be retained on the advise of such consultant which any company is ready to bear itself.

Such decisions are based on mathematical calculations against the rate of retaining the risk and payment of premium to insurance companies. In India there is an insurance scheme to compensate banks for loss on account of bad debts known as Deposit insurance and credit guarantee scheme which provides insurance to banks against unrecoverable loans.

But many banks decided to not to seek insurance cover under this scheme only because the amount of premium paid was much higher than the amount of insurance cover received . As such these banks decided to retain the risk instead of seeking the insurance cover.

Risk retention and a contingency fund should be a major part of any business plan no matter how small the company. A risk retention sometimes is well worth the potential savings in insurance costs. Proper planning will make a company run much more smoothly and be able to handle difficulties with a minimum of grief.

The strategies to manage risk include transferring the risk to another party, avoiding the risk, reducing the negative effect of the risk, and accepting some or all of the consequences of a particular risk.

Basically the risk retention is a process of handling greatest losses due to greatest possibility of miss happenings or eventualities which are required to be handled on first priority basis. The risks with lower probability of occurrence and lower losses can put on second priority.

But for managing risk of any type following steps are must:

a. Create value,

b. Be an integral part of organizational processes,

c. Be part of decision making,

d. Explicitly address uncertainty,

e. Be systematic and structured,

f. Be based on the best available information,

g. Be tailored,

h. Take into account human factors,

i. Be transparent and inclusive,

j. Be dynamic, iterative and responsive to change, and

k. Be capable of continual improvement and enhancement.