What is 'risk retention' in insurance practice?

Risk retention in insurance practice refers to the decision of an individual or an organization to assume responsibility for certain risks and their potential financial consequences. This strategy is often adopted when the costs associated with purchasing insurance for those risks are deemed higher than the risks themselves or when an entity may prefer to handle the risk internally. By retaining risk, the policyholder effectively takes on the possibility of loss instead of transferring that risk to an insurer.

This approach can be part of broader risk management strategies where an entity evaluates its risk exposure and decides which risks it is prepared to absorb. It involves analyzing the potential outcomes and ensuring there are resources available to manage those outcomes if they occur. For example, a company might choose to retain the risk of small equipment damage instead of purchasing a policy that covers it, reflecting a confidence in its ability to handle the financial implications of potential losses.

In contrast, transferring risks involves outsourcing certain risks to an insurance company, while avoiding risks means taking action to prevent exposure completely. Minimizing risks through regulation can also involve compliance with laws and standards but does not directly imply that risks are retained. Thus, the assumption of responsibility for losses distinctly defines the concept of risk retention.