Definition
Retention of Risk refers to a risk management strategy where an individual or organization retains the financial responsibility for potential losses rather than transferring that risk to an insurer. Essentially, it involves assuming the total financial impact of risks without purchasing insurance or seeking indemnity.
Meaning
In simpler terms, risk retention is the act of taking on the cost of losses personally or within the company. It often means setting aside funds to cover potential losses that might occur, ensuring that the entity does not rely on an external insurance provider.
Etymology
The term “retention” originates from the Latin “retentionem” which means “a holding back” or “keeping in possession.” Thus, retention of risk denotes the act of keeping the risk rather than passing it on to another party.
Background
Risk retention is often employed when the cost of insurance premiums outweighs the potential benefits or in scenarios where certain risks are deemed manageable internally. It encompasses self-insurance strategies and is widely used by large corporations with substantial financial cushions.
Key Takeaways
- Risk Responsibility: The entity takes full responsibility for potential losses.
- Cost-Benefit Analysis: Often chosen when insurance costs are higher than the potential risk itself.
- Fund Allocation: Usually involves setting aside specific funds to cover potential losses.
Differences and Similarities
Differences
- Risk Transfer: Unlike risk retention, risk transfer involves purchasing insurance to cover potential losses.
- Risk Sharing: Involves spreading risk among multiple parties, unlike retention which holds full responsibility.
Similarities
- Both are integral parts of a comprehensive risk management strategy.
- Both seek to mitigate the financial impact of potential risks.
Synonyms
- Self-Insurance
- Risk Assumption
- Non-Insurance
Antonyms
- Risk Transfer
- Risk Diversification
- Insurance Purchase
Related Terms with Definitions
- Deductible: The amount paid out of pocket before an insurance provider compensates for losses.
- Loss Retention: Identical to retention of risk where losses are absorbed by the entity instead of being transferred.
- Risk Management: The process of identifying, assessing, and prioritizing risks, followed by coordinated efforts to minimize, monitor, and control the impact of these risks.
Frequently Asked Questions
What is the retention of risk in insurance?
Retention of risk in insurance refers to assuming responsibility for financial losses rather than transferring risk through an insurance policy.
Why is risk retention a preferred strategy for some businesses?
Businesses may prefer risk retention to save on insurance premiums, have better control over their cash flow, and efficiently manage foreseeable risks.
What are some examples of risk retention?
Common examples include self-insuring for company health benefits, setting aside funds for potential product liability claims, or retaining small-scale property damage.
Questions and Answers
Why would a company choose risk retention over insurance?
A company may choose risk retention over insurance if the potential payout for risk is less than the cost of insurance or to maintain control over risk management.
What is the primary disadvantage of risk retention?
The primary disadvantage lies in the potential for significant financial loss if an unexpected or large-scale event occurs that the entity isn’t prepared to handle.
Exciting Facts
- Well-known multinational companies often use risk retention for specific types of risk to streamline their operations and reduce outgoings on insurance premiums.
- Risk retention can enhance a company’s risk awareness and lead to more robust internal controls.
Quotations
“Risk comes from not knowing what you’re doing.” – Warren Buffett
Proverbs
“Better the devil you know than the devil you don’t.”
Humorous Sayings
“Why pay others to worry when you can keep all the headaches for yourself?”
References
- Principles of Risk Management and Insurance by George E. Rejda
- Risk Management and Corporate Sustainability in Aviation by Triant G. Flouris and Sharon L. Oswald
Related Government Regulations
- Risk-Based Capital Requirements: US - Regulation requires that insurers maintain capital in proportion to the risk levels.
- Solvency II Directive: EU - A regulatory framework that dictates capital requirements and risk management strategies for insurance companies.
Further Studies
- Risk Management for Enterprises and Individuals by John Marshall and Michael K. Ronen.
- Enterprise Risk Management: Today’s Leading Research and Best Practices for Tomorrow’s Executives by John Fraser and Betty Simkins.
“Embrace the thrill of risks; for in them lies the bright tapestry of possibilities.” — Jonathan Reeves
