What is Risk Retention?
INTRODUCTION
Every profit-making organization assumes certain business risks every day it is in operation. Many businesses have begun to realize that they can also profitably assume some of the risks that they have in the past, transferred to an insurance company. In fact, there is greater predictability with some insurance risks than most business risks encountered.
The reasons risk retention can be beneficial are:
- There is a charge for risk transfer to an insurance company, which is generally 40% to 50% more than is paid in losses, depending on the type of coverage and the amount of premium involved.
- It is inordinately expensive to document and settle relatively small losses, particularly when management time is considered.
- The collection of small losses can frequently have an adverse effect on future insurance costs.
RISKS ALREADY RETAINED
Most organizations already retain some insurance risks. For example
- They have deductibles applicable to portions of your existing property and income coverages.
- Have self-insured retention on some of their Liability coverages.
- They have no insurance coverage on various catastrophes such as flood and earthquake
| See the Financial Ratios explained section to assist in your understanding of these retention guidelines. This may not be for the financially faint of heart, but it should give you some idea of the care with which we analyze and assess our clients risk management. |
|
RISK RETENTION LEVEL DETERMINATION
Only your executive and financial officers can determine the extent to which you should retain insurable risks and the extent to which your firm can comfortably absorb financial fluctuations in any given year. They can consider sales projections, cash flow requirements, shareholders’ profit expectations, loan covenants, legal and accounting tax position, etc. All of these factors influence your ability (and willingness) to assume rather than insure given exposures to loss.
RISK RETENTION LEVEL GUIDELINES
To date, no precise formulas exist to determine a firm’s proper risk retention level, but there are several guideline formulas or “rules of thumb” that have been developed. These guidelines are as follows:
[a] Accountants’ Materiality Test
- A guideline used by accountants as a. measure of materiality is 5 % of net income before taxes from continuing operations.
- Based on an organization’s pretax income from continuing operations of $250,000 for example, this guideline suggests they can safely retain up to $12,500 per year in unexpected losses.
[b] Net Working Capital. Method
A guideline used to determine a company’s ability to quickly fund an unexpected loss, rather than its long-term financial ability to absorb loss, is 1%-5% of net working capital (The retention selected should not reduce a firm’s current liability ratio below 2:1.)
Based on a hypothetical firm’s financial information, this guideline could produce the following results:
| Total Current Assets |
$1,000,000 |
| Total Current Liabilities |
$ 500,000 |
| Net Working Capital of |
$ 500,000 |
| Amount of risk retention |
(1%) low range $5,000 |
| to (5%) high range $25,000 |
|
[c] New Quick Method
This guideline measures a firm’s ability to cover a sudden emergency using assets that can be quickly converted to cash. It calculates current assets less inventories and current liabilities to determine a firm’s “net quick” and then assumes that 1%-5% of that amount can be absorbed.
For example, based on a firm’s financial information, this guideline produces the following results:
| Total Current Assets |
|
$1,000,000 |
| Less |
Inventories |
$100,000 |
|
Current Liabilities |
$500,000 |
| Net “quick” |
|
$400,000 |
| Amount of Risk Retention |
(1%) of Low range |
$4,000 |
|
(5%) of Low range |
$20,000 |
|
This method may provide an indication of the appropriate “per occurrence” retained amount.
[d] Earnings/Surplus Method
This guideline sets the annual amount of losses to be retained at a percentage (usually 1% -5%) of current earned surplus and an equal or lower percentage of the average pretax earnings for the past three to five years. This approach logically assumes that retained losses are payable from either pretax or retained earnings.
Based on the following hypothetical financial information, this guideline produces the following results:
| Current Earned Surplus |
|
$500,000 |
| 5 Year Average Pre-Tax Earnings |
|
$250,000 |
| TOTAL |
|
$750,000 |
| Amount of Risk Retention |
(1%) Low Range |
$7,500 |
| (5%) Low Range |
$37,500 |
|
[e] Percentage of Sales Method
This guideline suggests a range of possible risk retention amounts equal to one-tenth of one percent to one percent of annual sales. The HIGH range is normally associated with retention capacity for the sum of all retained occurrences in one 12-month period.
For example,
| Annual sales |
$25,000,000 |
Amount of Risk Retention:
- Low Range .1%
- High Range 1%
|
25,000
250,000 |
|
[f] Earning Per Share Method
Some firms regard the impact of uninsured loss on earnings per share as a valuable guideline for determining the upper limits of annual loss retention.
- A range of $.10 to $.20 per share is normally acceptable on an after-tax basis. (When dealing with earnings per share figures, you should bear in mind that a decision to retain risk rather than transfer it to an insurance company would eliminate most elements of normal premium expense, which would otherwise be charged against earnings. Therefore, it may be possible to consider higher earnings per share variances than those used here.)
By example, based on the current number of outstanding shares for a hypothetical company, this guideline produces the following results:
| $.10 X 250,000 shares |
= $25,000 (Low Range Retention) |
| $.20 X 250,000 shares |
= $50,000 (High Range Retention) |
|
RECOMMENDATIONS
- Annual Review – The principle single measure of a firm’s loss-absorbing capacity is its revenues, its “financial bulk.” When a sudden expense such as a loss occurs, expenditures are shifted, projects deferred, or finances juggled to accommodate the change. Most budgets have a certain degree of flexibility, which is one measure of the “tolerable loss level.”
- Earnings/Surplus – In Long and Gregg’s Property and Liability Handbook, Bernard Daenzer states that the minimum risk-bearing capacity “certainly should be 1% of its average annual net earnings during the last five years.” “Free surplus” may be the amount of surplus available for dividends, and the figure obtained would be an annual, rather than per-loss, figure.
- Aggregate Allowable Cost Variation – Some finance officers establish limits within which the risk retention level may vary–say, to a maximum of 150 percent of budgeted costs. The risk retention level should be that with the highest probability of remaining within the established limit, with the addition of total premium.
- Materiality – In general, 5 percent of net earnings is considered a material impact, which should be specifically footnoted in the financial statement.
5. RISK RETENTION SUMMARY
The risk retention guidelines indicate that organizations can retain risk in varying amounts, and we use these guidelines to assist in determining what makes sense in different situations.
- Once those levels are determined, they can be incorporated into your insurance and risk management program through the selection of individual deductibles, self-insured retention, self-insurance and/or non-insurance.
- 6. RISK RETENTION APPLICATION
- In the various sections of our survey, we discuss the desirability of deductibles, self-insured retention, self-insurance and non-insurance as they apply to specific risks or types of insurance. The size of these deductibles, retentions etc., should not be solely a function of your firm’s ability to retain risk. Other factors must be considered.
- For example, if insurance is too costly, the perils of earthquake and flood may be retained, even though the loss potential is beyond generally desirable retention limits, or the amount of a deductible on a specific coverage may be less than your risk retention capacity if the premium savings offered on larger deductible amounts are too small to justify their acceptance.
http://harder.com/html/risk_retention.html
Barney Frank indicates that there is a Risk Retention Crisis going on at this time. How does this affect the consumer?
How has this affected the economic crisis in general? What role has greed by banks and large corporations contributed to this “Risk Retention Crisis”?
How has the current economic situation spurred on fraudulent practices by US financial entities? Feeling the pain, but powerless to do much, but share information that can be found helpful to others.
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A Risk Retention Group (RRG) is a type of insurance company. The way that an RRG is different than a “traditional” insurance company is that each of its policy holders are also stockholders. In addition most insurance companies are formed under state laws but RRGS are formed under federal laws – The Federal Liability Risk Retention Act of 1986.
A RRG will allow members who engage in similar or related business or activities to write liability insurance for all or any portion of the exposures of group members, excluding first party coverages, such as property, worker s compensation and personal lines. Authorization under the federal statute allows a group to be chartered in one state, but able to engage in the business of insurance in all states, subject to certain specific and limited restrictions. The Federal Act preempts state law in many significant ways.
The 1986 Liability Risk Retention Act allows two types of insurance entities to form, an RRG and also a Risk Purchasing Group (RPG).
The act states that a risk retention group must form as a liability insurance company under the laws of at least one state which is considered its state of domicile. The owners of the risk retention group are also its insureds.
A risk retention group must insure businesses of a similar type in regards to their liability exposures. Once domiciled in one state the RRG must be excepted by all other states but the RRG must register in each state which it wishes to do business.
Advantages: Avoidance of multiple state filing and licensing requirements. Member control over risk and litigation management issues. Establishment of stable market for coverage and rates. Elimination of market residuals. Exemption from countersignature laws for agents and brokers. No expense for fronting fees. Unbundling of services.
Disadvantages: Risks are limited to liability insurance. Not permitted to write outside business. No guaranty fund availability for members. May not be able to comply with proof of financial responsibility laws.
Companies who are risk retention groups
- Evergreen USA RRG
- GovTech
- Global Hawk Insurance(RRG)
References
source Wikipedia
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So we can assume that banks like METABANK always had in place some kind of an insurance to cover their losses. On the other hand, METABANK was seeking out consumer’s vulnerabilities, and this may have been their chosen form of insurance.
Why the need to lie to customers?
This factor led me to do my own research and find all of the areas where METABANK operated and also lied to other customers. The reason behind this was that they needed to make money and lower their own risk. Their so called “creativity” made an adversary out of the customer and the partner company as well. This is not how I see our country operating in the future. We are essentially a compassionate and caring people, but this sets us up to be taken advantage of by banks like METABANK.
It will be for the American public to rally together to get reforms in place.
On the other hand we are being misled by some well paid media types who are ranters and who call anyone who disagrees with them a “liberal” and a “whiner” all while twisting the facts.
The simple fact of the matter is that I was scammed by METABANK and I would like to prevent that from happening to any other person.
Change is needed. A progressive frame of mind is also needed to get us up and out of this mire and pit of doom created by the greediness of banks like METABANK. We are all in this together, but we are being pitted against each other through the clever fear tactics of some media types who also tend to push blame off onto others.
Only the American consumer can get the necessary changes.
Vote.
Then be sure that whomever wins addresses your genuine needs based on your own personal experience. Yes, based on your own actual lived experience and not on hearsay.
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