RISK RETENTION: Definition and Best Strategies

risk retention
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In their daily operations, business owners face numerous risks. These risks are typically transferred to insurance companies by purchasing an insurance policy. However, not every company chooses this risk management strategy. Many businesses choose to pay their losses out of pocket rather than purchase insurance. There are many factors that influence risk retention; in this guide, we will explore the concept of risk retention and introduce a viable captive insurance solution called the risk retention groups (RRGs) and its example. 

What Is Risk Retention?

Risk-retention is the decision of an individual or organization to accept responsibility for a specific risk; rather than transfer the risk to an insurance company by purchasing insurance. This means that the individual or organization has chosen to pay for any losses out of pocket; rather than purchase insurance to shift the financial burden of a loss to a third party.

Companies frequently take risks because they believe the cost of doing so is less than; the cost of fully or partially insuring against them. Shoplifting losses are one example of risk retention; which many businesses choose to retain rather than purchase or claim on their crime insurance policy.

Another reason a company may decide to keep a risk is if it is uninsurable or falls below the policy deductible. In this case, it is known as “forced retention.” Insurance companies must also make a decision on which risks to cover.

How Risk Retention Works

When a company chooses or is forced to retain a certain risk, it will be responsible for paying any losses from that risk out of pocket. As a result, it is critical for businesses to ensure that they can afford to pay for potential losses before deciding to retain specific risks.

Often, the funds can come from current cash flows, reserve funds set aside for these types of losses, or; if they are frequent and predictable enough, they can be incorporated into the monthly budget.

Risk-retention can be done voluntarily or involuntarily.

The decision to retain a risk voluntarily is usually based on economic considerations. Many companies will choose to voluntarily retain the risk of the losses if they occur frequently enough to be budgeted for or if the premiums for insuring against this risk are too high. Because they are large enough to absorb potential losses, large organizations; such as railway operators or government bodies, may choose to forego insurance and retain almost all of their risk. These organizations can save money by not buying insurance.

Companies are sometimes forced to retain risk or loss. This occurs when the risk is either excluded from their coverage; uninsurable, or the loss value is less than their policy deductible.

Advantages of Risk Retention

Insurance is not required for risk-retention strategies. This is because the long-term costs of insurance exceed the cost of the risks when they occur. As a result, it saves companies a lot of money.

If insurance is purchased, the premiums far outweigh the actual risk costs. This is due to the fact that the risk profile considered for an individual company differs from the individual average values used to calculate premiums.

Disadvantages of Risk Retention

Risk retention is entirely determined by the manager’s decision rather than by market conditions. As a result, it may result in increased losses rather than any other method of mitigating them.

Aside from the risks that have been assessed and insured, any other financial losses are considered to be accepting risks. This expands the portfolio of unanticipated risks.

Risk Retention Groups

The Risk Retention Groups must be registered with the Company Licensing and Registration Office. Risk Retention Groups (RRGs) are governed by the Texas Insurance Code (TIC), Chapter 2201; the Texas Administrative Code (TAC), Chapter 13. Risk Retention Groups (RRGs) are self-insurance pools formed to retain risks for a specific group of insureds who share a common interest. The common interest, however, must not be solely for the purpose of obtaining insurance; but because the insureds are part of a cohesive group with similar liability exposure.

Risk Retention Groups (RRGs) only provide third-party liability coverage, which may include general liability, errors and omissions; officers and directors, medical malpractice, professional liability, and product liability. Workers’ compensation, property insurance, and personal insurance such as homeowners’ and personal auto, on the other hand, are not permitted under the Federal Liability Risk Retention Act (LRRA). Furthermore, in accordance with TIC, Section 2201.251, as amended in the 83rd Texas Legislative Regular Session, certain groups may maintain peripheral coverage.

Checklists and Registration Forms

Registration Requirements for Risk Retention Groups

A Risk Retention Group must comply with certain filing requirements before doing business in Maryland; according to Section 25-103 of the Insurance Article, Annotated Code of Maryland, and Code of Maryland Regulations 31.06.03.03.

Companies must submit the following documents to be considered for initial eligibility:

  • Part B of the Risk Retention Groups Application
  • A copy of the most recent annual statement filed with the state where the risk retention group is chartered and licensed
  • An independent certified public accountant prepared an audited financial report for the previous calendar year.
  • A member of the American Academy of Actuaries or a qualified loss reserve specialist provides an opinion on loss and loss adjustment expense reserves.
  • The most recent Examination Report issued by the Insurance Regulatory Agency of the applicant’s state of domicile.
  • The Risk Retention Group’s operational plan or feasibility study.
  • A $75 non-refundable application fee should be made payable to the Maryland Insurance Administration.
Read Also; RISK BENEFIT ANALYSIS: Definition, Cost & Examples

A Risk Retention Group that wants to renew its status as a qualified Risk Retention Group in Maryland can do so online, as long as the company submits the following documents annually via email or mail:

  • Application for Renewal
  • A copy of the most recent annual statement filed with the state where the risk retention group is chartered and licensed
  • An independent certified public accountant prepared an audited financial report for the previous calendar year.
  • A member of the American Academy of Actuaries or a qualified loss reserve specialist provides an opinion on loss and loss adjustment expense reserves.
  • The most recent Examination Report issued by the Insurance Regulatory Agency of the applicant’s state of domicile.
  • The Risk Retention Group’s operational plan or feasibility study.

Between May 1 and June 30, the authorization must be renewed. You must pay the renewal fee of $25 with a Visa, Mastercard, Discover, American Express, or eCheck. There is no additional fee for renewing online. If you renew by credit card, the charge will appear on your statement as “Maryland Insurance Administration.”

Example of Risk Retention

It may appear counterintuitive for a business owner to forego insurance protection for certain operational risks; after all, property and casualty insurance is the foundation of modern risk management. Nonetheless, there are several reasons why a company would choose to keep risks. Here’s an example of risk retention:

  • When a business owner determines that the cost of loss coverage is less than the cost of paying for partial or full insurance coverage. Consider high frequency, low-value losses like shoplifting or vandalism; these losses can be paid for out of pocket for less than the cost of funding and maintaining insurance protection.
  • When a specific risk is uninsurable, is excluded from insurance coverage, or when losses are less than insurance policy deductibles. This is referred to as “forced risk retention” at times. Again, high frequency/low-value losses or an inability to find appropriate insurance coverage may prompt business owners to make this decision.

When deciding whether to retain risks, business owners must make one critical decision: whether they can afford to pay for any losses upfront.

Other Risk Retention Examples and Alternatives

Damage to an outdoor metal roof over a shed is an example of risk retention that a company may be willing to retain. Instead of purchasing an insurance policy to cover the replacement of the shed’s roof, the company may decide to set aside funds for its eventual replacement.

Rather than accepting full responsibility for risk, a company may opt for a partial retention approach to the risks it faces. In this case, the company will transfer a portion of the risk to an insurer in exchange for a premium but may be liable for a deductible. Alternatively, it may be liable for any losses that exceed the coverage provided by an insurance policy. If the company believes the risks are minor, it may opt for a policy with a high deductible, which usually results in a lower premium and thus more cost savings.

A company may also unintentionally assume complete retention if it fails to identify risk and thus fails to pursue a risk transfer strategy. In this case, the company is uninsured by default because it did not purchase insurance and was unaware that it could.

Conclusion

To summarize, there are several approaches and treatments for risk in risk management. They are as follows:

  • Avoidance: Entails altering plans in order to eliminate risk. This strategy is appropriate for risks that could have a significant impact on a business or project.
  • Transfer: This is applicable to projects involving multiple parties. It is not commonly used. Insurance is frequently included. Insurance policies, also known as “risk-sharing,” effectively shift risk from the insured to the insurer.
  • Mitigation: Reducing the impact of risk so that if a problem arises, it is easier to resolve. This is the most typical. Hedging strategies, also known as “optimizing risk” or “reduction,” are common forms of risk mitigation.
  • Exploitation: Some risks are beneficial, such as when a product is so popular that there aren’t enough employees to keep up with sales.

Risk Retention FAQs

What is an example of risk retention?

Damage to an outdoor metal roof over a shed is an example of a risk that a company may be willing to retain. Instead of purchasing an insurance policy to cover the replacement of the shed’s roof, the company may decide to set aside funds for its eventual replacement.

What are the reasons for risk retention?

Why Retain Risks?

  • When a business owner determines that the cost of loss coverage is less than the cost of paying for partial or full insurance coverage.
  • When a given risk is uninsurable, is not covered by insurance, or when losses are less than the insurance policy deductibles.

What are risk retention techniques?

Risk-retention is the deliberate decision of organizations to handle a firm’s opposing risk internally rather than transferring it to insurance or another third party.

What is risk retention and its importance?

Risk-retention is the decision of an individual or organization to accept responsibility for a specific risk rather than transferring the risk to an insurance company by purchasing insurance.

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