Good risk managers continually reassess strategies to address uncertainty and mitigate risk, especially in a changing environment. This article recommends that increased risk retention as a strategy deserves a fresh look because the hardened commercial insurance markets have changed both the availability and costs of commercial insurance.
Time to reassess
In normal commercial insurance markets, transferring certain risks to an insurance company for a reasonable premium often makes the most business sense. Even before the pandemic struck, however, commercial insurance markets were roiled by decreased capacity, reduced coverages and sharply escalating premiums across many lines of insurance products, especially in property, casualty, umbrella and D&O. This disruption in the commercial insurance markets defies prediction or control by policyholders. To regain some measure of control over risk financing in a longer term “hard market”, organizations should consider a strategy of retaining risk using one or more of the available risk retention tactics.
Risk Retention as a Strategy
In practice, most organizations use a combination of risk retention and transfer. The goal is to find the right combination of retention/transfer based on the organization's risk tolerance, financial capacity and its ability to diversify retained risks and administer retained losses.
Done properly, the correct combination of risk retention/transfer should benefit an organization by reducing reliance on commercial insurance and save costs of risk in premium payments, provide more stability in the cost of risk over time and improve coverage and satisfactory limits. Taken to the ultimate retention of risk where risk is transferred to a single parent captive insurance company, the organization gains increased control over the program and its component parts, ability to allocate costs of risk across the enterprise, potential to create a new revenue stream, and possible ability to take advantage of certain tax efficiencies.
Risk Retention Tactics
There is a continuum of risk appetite and risk financing of retention tactics that spans a range of funding structures that present different degrees of control, formality and flexibility. These programs include the following from less formalized to more formalized options:
Modest deductibles paid from usual operating funds and not budgeted,
Higher retentions/deductibles budgeted but not funded,
High retentions/deductibles budgeted and funded before payment,
Formal prefunded vehicles such as trust, groups and pools, and
Licensed captive insurance companies, such as single parent (primarily risk retention) or group (some risk retention, some risk transfer)
Investing time and energy to investigate and analyze retaining more risk in a comprehensive risk management strategy makes sense in today’s unusually hard insurance market which shows no signs of moderating in the foreseeable future. The key to controlling costs and coverage is retaining an appropriate level of risk. Then determine which risk retention tactic or tactics best serve your organization’s needs.