Chapter · January 998 doi: 10. 1007/978-1-4615-6187-3 10 citations reads 2,488 author: Some of the authors of this publication are also working on these related projects
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10.Retentionandcaptiveinsurance (1)
The Concept of Retention
If partial insurance is purchased, other financial decisions are required to fund the retained portion of the expected losses. Retention is usually defined as the decision of the risk manager to retain part or the total of the preloss financing decision. If retention is "unplanned," then losses will be paid from whatever financial resources are available to the firm. If the risk manager is not aware that a certain loss exposure exists and consequently does not attempt to deal with it, his ignorance can have serious consequences for the firm. However, there is no reason to define ignorance as a "passive retention" method of risk management.
Planned retention is the result of a risk management decision. As far as we are concerned here, this is the only case where a pre-loss decision has to be made to finance the retained portion of the expected loss. Of course, if insurance coverage is not available, retention becomes the only possible risk financing tool for the firm. 5
A critical problem facing the risk manager is the decision concerning the optimal level of risk retention. The objective is to reduce the costs by retaining the most predictable losses. Cash flows that are regular and predictable can be managed within the budgetary constraints of a firm, without outside funding, and without the need to maintain large cash balances.
Retention decisions, therefore, are often based on the information available concerning loss exposures, on cost-saving possibilities for the firm, on specific managerial objectives and on the aversion towards risk of its managers ( Table 10.1).
An understanding of the role of deductibles in the pricing of insurance contracts is important in evaluating the potential saving. Firms with a large number of loss exposures are able to estimate the frequency and severity distributions of losses more accurately. The final decision will combine retention and insurance alternatives as shown in Figure 10.1.
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