How to quantify the Cost of Risk Retention

How to Quantify the Cost of Risk Retention

Risk retention, a strategic approach to risk management, involves assuming responsibility for potential losses rather than transferring them to a third party such as an insurance company. While it can be a cost-effective strategy, it's crucial to accurately quantify the financial implications of retaining risk.

The Cost of Risk Retention

The cost of risk retention is multifaceted and can include:

1. Direct Costs:

   • Loss Payments: These are the immediate costs associated with a loss, such as property damage, medical expenses, or legal fees.
   • Administrative Costs: Costs associated with managing the risk retention program, including staffing, systems, and processes.

2. Indirect Costs:

   • Lost Revenue: Disruptions to business operations, such as production downtime or supply chain disruptions, can lead to significant revenue losses.
   • Damaged Reputation: A major loss event can damage a company's reputation, leading to decreased customer trust and potential loss of business.
   • Increased Insurance Costs: Retaining certain risks can lead to higher insurance premiums for other coverage.

Quantifying Risk Retention Costs

To accurately quantify the cost of risk retention, you can employ various techniques:

• Loss History Analysis: By analyzing past loss data, you can estimate the frequency and severity of potential losses.
• Statistical Modeling: Statistical models can be used to predict future losses based on historical data and industry trends.
• Expert Judgment: Experienced risk managers can provide insights into potential risks and their associated costs.
• Scenario Analysis: By considering different scenarios, you can assess the potential impact of various risks.

Real-World Example: Retail Store Risk Retention

A retail store might decide to retain the risk of minor property damage, such as broken windows or minor theft. To quantify the cost of this risk, the store could analyze its loss history, consider the cost of repairs, and estimate the potential impact on revenue.

The store might also implement risk mitigation strategies, such as installing security systems and training employees in loss prevention techniques. By taking these steps, the store can reduce the frequency and severity of losses and, therefore, the cost of risk retention.

The Role of Insurance in Risk Retention

While risk retention can be a valuable strategy, it's important to balance it with insurance coverage. Insurance can provide a financial safety net for catastrophic losses that could devastate a business. By carefully selecting insurance coverage, you can transfer the risk of major losses to an insurance carrier.

Remember, while risk retention can be a cost-effective approach, it's essential to have a robust risk management framework in place to protect your business. You have to identify and scrutinize each risk factor independently to have a clear picture on the amount of risk your are assuming.

Contact us today if you would like to know the type of insurance products you would need to insure your existing risk.