Balancing risk transfer and risk retention

Determining an appropriate level of risk transfer or risk retention for an organization can be an arduous exercise.

There are a multitude of risk-financing strategies available to businesses of all sizes, each with their own advantages and disadvantages. From self-insurance programs to risk-sharing with industry peers to programs that allow greater control over claims processing and loss drivers, the strategies vary in complexity and cost.

As businesses seek out creative and cost-efficient ways to finance their exposure to market-changing events — such as natural catastrophes, cyberattacks and terrorism — maintaining a clear line of sight into potential financing options when it comes to formulating risk transfer or risk retention strategies is critical.

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Understanding the risk-financing continuum

Think of risk financing as a continuum between total risk transfer on one end of the spectrum and total risk retention on the other end. Total risk transfer, such as a guaranteed cost program, provides maximum cost certainty but is typically a less efficient use of capital and offers less control, given the carrier’s involvement and charges for assuming full risk. Total risk retention through self-insurance offers the lowest cost certainty given that costs are significantly impacted by losses, but it also provides greater cost efficiency and control. The key is achieving the right balance of risk retention, program control and savings potential.

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The role of the risk advisor

The role of risk advisors in this balancing act is crucial. Experienced risk advisors can help organizations determine the best risk-financing program or strategy by conducting a detailed analysis of their risk management profile, risk-taking philosophy and appetite. For example, the analysis may include the size and type of the company’s operation, near-term and long-term goals, financial position and current risk control programs.

These are just a few of the critical risk factors that should be considered when constructing an appropriate risk-financing strategy. From that point forward, the focus of the risk management team should center on identifying the right balance between the organization’s need for budget certainty, ability to retain risk, ability to manage claims, and the potential for program savings.

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Evaluating the right strategy

Guaranteed cost plans, dividend programs, deductible plans and group captives are all different types of risk-financing strategies. As an example, consider the case of a valve manufacturer that was paying more than $1 million in guaranteed cost premium for workers’ compensation coverage. The company’s executive team was extremely risk-averse and had never considered retaining risk as an option. After partnering with their risk advisor to conduct an in-house actuarial analysis, the results showed that assuming a deductible of $100,000 would save the company $500,000 in premium at their next renewal.

By switching to a deductible program, the company was able to significantly reduce their total cost of risk, as well as spread out loss payments over a five- to seven-year period, providing improved cash flow and the opportunity to reinvest the available funds back into the growth of the organization.

A complete, actuarial-based analysis is required to determine where an organization falls on the risk-financing continuum and what financing options are most consistent with its risk profile. Organizations should work with their risk advisor to determine which risk-financing option is most appropriate for them.

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Renee Dube, vice president, national property & casualty practice at USI Insurance Services, is based in Valhalla, N.Y. Renee can be contacted at renee.dube@usi.com or 914-749-8532.