Risk retention is a term used to describe the practice of an organization accepting and managing certain risks that may negatively impact its operations. This strategy involves the decision to not transfer the risk to an insurance company, but instead, to retain the risk within the company’s own finances. While this approach has its advantages, it also comes with several drawbacks.
One of the primary benefits of risk retention is the ability to have more control over the management of potential risks. By undertaking this approach, businesses can tailor their risk management strategies to the specific needs of their operations. This means that companies have the freedom to make decisions about the level of risk they are willing to take on and the allocation of resources to address particular risks.
In addition, risk retention can provide significant cost savings for businesses. Transferring risks to an insurance company comes with a cost, such as insurance premiums, and insurers may not offer coverage for certain types of risks. By retaining risks within the organization, companies are free from the expenses of insurance premiums, brokerage fees, and the costs associated with claims administration.
However, there are also drawbacks to this approach. The most significant risk associated with risk retention is the potential for financial loss in the event a significant risk materializes. Companies must actively manage the risks they retain through appropriate risk assessment and mitigation strategies. If risks are not properly managed, the financial consequences of a significant event can be catastrophic for the business.
Another disadvantage of risk retention is the lack of diversification. When a company retains risks, it means that it is relying on its own financial resources to cover losses. If a significant event occurs, it could place a significant strain on the company’s financial resources, potentially leading to insolvency. By contrast, insurance can offer a broader and more diverse range of coverage options that can help protect against a broader range of potential damages.
In summary, risk retention has its benefits and drawbacks for businesses. It can provide more control over the management of potential risks and significant cost savings. However, it also exposes the company to financial loss in the event a significant risk materializes, and it lacks the diversification offered by insurance. Companies should weigh the advantages and disadvantages of risk retention carefully and develop a comprehensive risk management strategy that appropriately addresses their unique business risks.