Question

Discuss the benefits and the cost of increased risk retention?

Answer 1

Companies retain risk when instead of transferring the risk to a third party such as an insurer they decide to retain the risk on themselves. The increased risk retention can have benefits but could also result in additional costs that could have serious effect on the working of the company

Some Benefits of the Risk Retention

• Less Premiums :- Insurance companies charge higher premiums for higher risks , by retaining a large part of risk on themselves companies could reduce the amount spend on premiums and use it for other activities.
• More Savings , Less Expenses : - When companies retain the risk on themselves they tend to save more and spend less on unnecessary activities due to higher risk of uncertain cash flows in the future .Also it is expensive to settle small losses with insurance companies when management's time is considered.
• Encourage Risk  Prevention Activities :- When companies bear risk on themselves they tend to be more proactive in reducing the impact of that risk on the organisation , by diversifying their business this risk could be reduced.
  
  Cost Of increased risk retention
• Increase in overall Risk : If you retain more and more risk , there would come a time when your ability to bear risk will come to an end and the organisation as a whole would be a higher risky investment , investors will not prefer a risky investment when returns are highly uncertain due to risk taken by the organisation .
• No Coverage : - If you don't have a coverage or insurance supporting your contingent liabilities , you may face severe losses in the future and company may have to shutdown because of it .
• Higher Probability of Default :- Companies with higher risk have higher probability of default if things don't go according to their plan and have credit rating less than the low risk company .
• Must compensate with higher return : - if you don;t transfer the risk you have to compensate investors with higher returns for the risk taken by the investors.