Definition
Risk retention is a method of self-insurance used by organizations or individuals to set aside a reserve fund specifically for offsetting unexpected financial claims. Unlike traditional insurance where risk is transferred to an insurer, risk retention involves the organization handling potential risks internally by maintaining sufficient reserves to cover any possible losses.
Examples
- Corporate Reserve Fund: A large corporation may choose to retain risk by creating a reserve fund to cover potential legal claims or product liabilities instead of purchasing liability insurance.
- Healthcare Self-Insurance: A healthcare organization might retain risk by setting up a fund to manage the costs associated with medical malpractice claims rather than buying malpractice insurance.
- Municipal Self-Insurance: A city or municipality might retain risk for public liability claims by maintaining a reserve fund instead of securing general liability insurance.
Frequently Asked Questions (FAQs)
Q1: What is the primary advantage of risk retention?
- A1: The primary advantage of risk retention is cost savings. By not transferring risk to an insurance company, organizations can save on premium costs and have more control over their funds and loss prevention strategies.
Q2: When is risk retention most appropriate for an organization?
- A2: Risk retention is most appropriate when the potential losses are predictable and manageable, and when the cost of insurance premiums outweighs the potential losses. It’s also suitable when an organization has the financial stability and capacity to reserve sufficient funds.
Q3: What are the main risks associated with risk retention?
- A3: The main risks include potential underestimation of reserve requirements, liquidity issues if multiple claims occur simultaneously, and the possibility of incurring losses that exceed the reserved funds.
Related Terms
- Self-Insurance: A form of risk management where an entity sets aside funds to cover potential losses rather than purchasing insurance from a third party.
- Contingency Fund: A reserve of money set aside to cover possible unforeseen future expenses or financial claims.
Online References
- Investopedia - Self-Insurance
- Wikipedia - Risk Retention
- National Association of Insurance Commissioners (NAIC) - Risk Retention
Suggested Books for Further Studies
- “Principles of Risk Management and Insurance” by George E. Rejda & Michael McNamara
- “Handbook of Risk and Insurance Strategies for Certified Public Risk Officers and other Water Professionals” by Frank Spellman
- “Risk Management and Insurance” by Scott E. Harrington & Gregory R. Niehaus
Fundamentals of Risk Retention: Insurance Basics Quiz
### What is risk retention commonly referred to as?
- [ ] Transfer of risk
- [x] Self-insurance
- [ ] External insurance
- [ ] Risk dissipation
> **Explanation:** Risk retention is commonly referred to as self-insurance because it involves setting aside a reserve fund to cover potential losses rather than transferring the risk to an external insurer.
### Why might an organization choose risk retention over traditional insurance?
- [ ] To eliminate all risk
- [ ] To avoid all claims permanently
- [x] To save on premium costs and have more control over funds
- [ ] To obtain larger insurance payouts
> **Explanation:** Organizations might choose risk retention to save on premium costs and have more control over their funds and loss prevention strategies.
### What is a key factor in deciding whether to use risk retention?
- [ ] The color of the company's logo
- [ ] The size of the company's marketing budget
- [x] The predictability and manageability of potential losses
- [ ] The number of employees
> **Explanation:** The predictability and manageability of potential losses are key factors in deciding whether to use risk retention. If losses are predictable and manageable, risk retention can be a cost-effective strategy.
### Which of the following would typically use risk retention?
- [x] Large corporations
- [ ] Small individual homeowners
- [ ] New business startups with limited capital
- [ ] Non-profit organizations with zero assets
> **Explanation:** Large corporations typically use risk retention as they have the financial stability and capacity to reserve sufficient funds for potential liabilities.
### What type of fund is maintained for the purpose of risk retention?
- [ ] Salary Fund
- [ ] Marketing Fund
- [ ] Equipment Fund
- [x] Reserve Fund
> **Explanation:** A reserve fund is maintained specifically for the purpose of risk retention to cover potential losses.
### What is a disadvantage of risk retention?
- [ ] Avoiding insurance premiums
- [ ] Increased insurance payouts
- [x] Potential underestimation of reserve requirements
- [ ] Reduced financial control
> **Explanation:** A disadvantage of risk retention is the potential underestimation of reserve requirements, which can lead to insufficient funds to cover losses.
### Which area is most likely to use risk retention?
- [ ] Branding
- [ ] Graphic designing
- [ ] Real estate
- [x] Medical malpractice claims
> **Explanation:** The medical field, especially concerning malpractice claims, is more likely to use risk retention because of the high insurance premiums associated with medical liability insurance.
### What is an important characteristic of an organization that adopts risk retention?
- [ ] A dynamic workforce
- [ ] Ambiguous financial records
- [x] Financial stability and capacity to reserve sufficient funds
- [ ] Startup-level resources
> **Explanation:** Organizations that adopt risk retention generally possess financial stability and the capacity to reserve sufficient funds to manage potential risks.
### What is a contingency fund?
- [ ] A regular expense account
- [x] A reserve of money set aside for unforeseen expenses or financial claims
- [ ] A fixed income revenue stream
- [ ] An employee benefits fund
> **Explanation:** A contingency fund is a reserve of money set aside for potential unforeseen future expenses or financial claims.
### Which method involves the organization handling potential risks internally rather than transferring them to an insurer?
- [ ] External insurance
- [x] Risk retention
- [ ] Risk elimination
- [ ] Direct settlement
> **Explanation:** Risk retention involves the organization handling potential risks internally by maintaining sufficient reserves to cover any possible losses rather than transferring them to an insurer.
Thank you for exploring the concept of risk retention with us and testing your understanding through our engaging quiz questions. Keep expanding your knowledge in risk management and self-insurance strategies!
