Business owners face many risks in their daily operations. Typically, these risks are transferred to insurance companies by purchasing an insurance policy. Not every business chooses this risk management path, however. In many cases, businesses choose to pay their losses out of pocket instead of purchasing insurance. This is known as risk retention. There are many factors that influence risk retention; in this guide, we will explore the concept of risk retention and introduce a viable captive insurance solution called the risk retention group (RRG).
Why Retain Risks?
It may seem counterintuitive for a business owner to forego insurance protection for certain operational risks; after all, property and casualty insurance is the foundation of risk management for modern businesses. Still, there are several reasons why a business would choose to retain risks. Examples include:
- When a business owner determines the cost associated with loss coverage is less than that of paying for partial or full insurance protection. Think of high frequency/low value losses such as shoplifting or vandalism; these losses may be paid for out of pocket for less cost than funding and maintaining insurance protection.
- When a given risk is uninsurable, is excluded from insurance coverage, or if losses fall below insurance policy deductibles. This is sometimes referred to as “forced risk retention.” Again, high frequency/low value losses or the inability to find appropriate insurance coverage may lead to this decision on the part of business owners.
Business owners must make one important decision when choosing to retain risks, and that is if they can afford to pay up front for any loss experiences. Losses may be paid for out of current cash flows or may be covered by setting aside a reserve loss fund. If the losses are frequent enough and predictable enough, they may even be incorporated into monthly/annual budgeting.
Risk Retention Groups
As the traditional insurance market has grown more expensive, many companies have chosen captive insurance as a cost-effective solution. Within captives, a model known as a risk retention group (RRG) has gained acceptance. In this self-insurance format, groups of business owners retain their risks by purchasing insurance through the RRG. RRGs were established in 1981 and were expanded in 1986 with the passage of the federal Liability Risk Retention Act. Under the Act, all members of a group must be business owners and must be insured through the group. Typically, RRGs are utilized by companies with similar risk profiles and operational parameters, such as legal or healthcare practices, architectural firms, and financial institutions.
It is important to note that not every RRG is a captive insurance entity; RRGs can be established under captive or traditional insurance regulations, and some states only allow the formation of RRGs under regular insurance business laws. For those business groups that do choose to retain their risks, RRGs serve as a cost-effective and flexible solution, helping to preserve business assets in cases of unexpected or high loss exposures.
About Caitlin Morgan Captive Services
Caitlin Morgan Captive Services provides clients with captive insurance solutions supported by years of experience in establishing the successful formation and implementation of a wide range of captives. To learn more about how we can help you, please contact us at (855) 975-4949.