Question

Give a real-world application of Risk Retention and explain.

(This would a 4-minute presentation topic. Please guide.)

Answer 1

The word Risk retention is generally used wherein a decision is to be taken by Corporation whether to own a risk or transfer the risk to some other entity typically more likely in Insurance ie to say a decision to take responsibility for a particular risk it faces, as opposed to transferring the risk over to an insurance company. Corporation often do cost benefit analysis to ascertain that the cost of doing so is less then the cost of fully or partially insuring against it. These are risk management technique wherein a company facing a risk or risks decides to absorb any potential loss rather than transfer that risk to an insurer or other party. Such corporations if they don't transfer the risk to other entities (insurance) they generally retain a reserve fund for the purpose of offsetting unexpected financial claims.

The idea of risk transfer is that the potential loss scenario may be shifted to some one who is in a better position to exercise such loss control.

There are few advantages and disadvantages of Risk Retention.

Advantage of Risk Retention

a) It saves cost

b) Helps is lowering of Expenses

c) It encourages to take steps for loss prevention

d) As it helps in reducing cost thereby support in lower cash outflow flow

Disadvantage of Risk Retention

a) Possibility of higher losses in case the unforeseen event occur

b) It may result in higher cost (for recovering/ replacement) if such unforeseen event occur

c) It may result in higher taxes.

Generally corporation's for establishing the optimal level of retained risk they need to address the following issues;

a) Risk Identification: Corporation need to review the range of risks faced by them

b) Risk Assessment: Conduct Risk assessment to determine level of confidence in risk management processes

c) Review Insurance Market: Conduct the review of Insurance market to determine state of market, attitude to risk pricing

d) Peer Review: If possible surveying the Peers to benchmark against a corporation in similar industry

e) Evaluation of Financial Ratios: Conduct the analysis and impact on key financial indicators in case of possible loss scenario.

f) Funding the losses ie Retention Funding: To assess the appetite for retaining the risk and ways to park funds for meeting contingencies.