Complete Retention

Updated on February 22, 2024
Article byKhalid Ahmed
Edited byKhalid Ahmed
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Complete Retention?

Complete Retention, or self-assumption, refers to absorbing potential financial losses due to unforeseen events straight forward into the business’s balance sheet without transferring the risk to an outside insurer or third party. It aims to remove the cost of risk transfer mechanisms such as paying insurance premiums or other risk transfers.

Complete Retention

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Companies use it primarily for covering minor property damage, employee health claims, cyber security instances, product liability claims, and professional liability claims. During significant accidents, they can be disastrous for the company involved. Financial service providers handle risks related to the services or products they use.

Key Takeaways

  • Complete retention is a risk management approach where a company assumes full accountability for bearing its losses independently, bypassing involvement with third-party insurers.
  • It saves on insurance premiums, maintains control over insurance claims, and fosters a proactive risk management ethos within the company.
  • It reduces reliance on insurance companies, invests in risk management systems, and develops innovative risk financing solutions.
  • Businesses can consider alternative strategies to complete retention, such as risk transfer via insurance, contingent debt financing, partial risk retention, risk reduction strategies, captives, risk retention groups, risk purchasing groups, deductible plans, and risk transfer agreements.

Complete Retention Explained

A complete retention strategy comprises a business risk management strategy where a firm takes all responsibility for taking losses directly without involving third-party insurers. Such a proactive stance can be taken by using no insurance, self-insurance, or deductibles. It helps save on potential costs of insurance premiums, provides control over insurance claims, and teaches a proactive risk management culture in a company. Nevertheless, it can have significant financial consequences during large-scale and costly breakdowns.

Such a strategy requires a meticulous and intensive risk management approach. For its implementation, a company must have robust financial reserves, sophisticated risk assessment, and proactive risk mitigation. As a result, its implication depends on the particular context of usage, which can include the impact on profits plus profits, increased revenues, and market mispricing. Local communities and colleges can benefit from increased financial stability and revenues.

In securitized products, their valuation may be affected by their credit quality. Moreover, retention regulations need to resolve the incentive problem of low-quality products. Moving on to its usability, it benefits large, financially stable companies that can absorb huge losses without affecting their operations. They also get used in industries with frequent and manageable risks and an advantage in cost savings.

Furthermore, companies have the convenience to handle higher levels of financial ambiguity and deploy it as their strategy. The above details lead us to the inference that it impacts the financial world in multiple ways. It reduces demands and dependency on traditional insurance companies and incentivizes companies to invest in sound risk management systems. Finally, it motivates firms to create innovative solutions related to risk financing, such as risk retention groups and captives to cater to self-insured entities.

Examples

Let us use a few examples to understand the topic:

Example #1

Let us suppose Sofia Adams founded IllumiTech, a tech business, on January 3, 2024, in the thriving town of Louisville. By returning all of the company’s revenues to R&D, Sofia, an inventive businesswoman, hopes to promote a complete retention approach. Her plan calls for keeping all post-tax earnings in order to guarantee a dividend payment ratio of zero percent. This strategy promotes rapid growth and technical improvements.

The IllumiTech team, under the direction of CTO Alex Chen, carefully allocates funds to innovative initiatives. They represent a dedication to total retention by constantly innovating without paying rewards and concentrating on AI-driven solutions. Sofia’s goal of total retention is proving to be a significant change for Louisville’s tech scene since it not only increases development but also cultivates an innovative atmosphere.

Example #2

Suppose Morgam Trucking Company in Locanty chooses not to purchase collision insurance. Instead, it chooses to self-insure against minor collisions for its fleet of Axy buses. They manage repairs on their own and lower insurance costs since they have reserve money in place. The hazards and benefits of total retention are demonstrated by the fact that this option entails accepting full responsibility for all accident-related expenses.

If there’s a big mishap, Morgam can have financial difficulties. By weighing possible savings against the inescapable financial risk associated with accidents, this strategic move highlights the company’s determination to manage risks internally.

Alternatives

In the case of a severe uninsured incident, the total retention strategy may be dangerous and expensive. As a result, businesses might think about these options instead of a complete retention approach:

  1. Risk Transfer via Insurance: Using insurance to reduce risks rather than full retention spreads out the exposure to risk.
  2. Contingent Debt Financing: Numerous risks can be managed without being fully retained by using various contingent loan instruments.
  3. Partial Risk Retention: A balanced strategy involves transferring some risk through hedging or other financial instruments and selectively holding onto other components.
  4. Risk Reduction Strategies: Putting quality control, diversity, and safety procedures into practice as risk management techniques to prevent or lessen possible losses.
  5. Captives: Establishing a subsidiary insurance business to take on certain risks on one’s own. Cooperation uses it with other institutions quite frequently.
  6. Risk Retention Groups (RRGs): Creating nonprofit groups with related companies in order to share resources and obtain self-insurance.
  7. Risk Purchasing Groups (RPGs): Collectives make it possible to bargain for lower insurance costs.
  8. Deductible Plans: Choosing large deductibles in order to reduce premiums and transfer more of the upfront costs to the insured.
  9. Risk Transfer Agreements: Assigning some risks to a third party in exchange for money.

Frequently Asked Questions (FAQs)

1. What is the complete retention ratio?

A complete retention ratio is the percentage of net income held by a business to fund its expansion instead of being distributed as dividends.

2. What is the formula for the complete retention ratio?

The percentage of profits that a business retains for expansion and reinvestment, as opposed to distributing dividends to shareholders, is measured by the retention ratio. The formula of this ratio is as follows:
Total Retention Ratio = Earnings Retained ÷ Net Income

3. What are the benefits of a complete retention ratio?

The advantages of the retention ratio include the following:
Financial Stability: The retained earnings serve as a safety net against downturns in the economy.
Strong Growth: Businesses finance marketing, R&D, and expansion through reinvesting earnings, all of which increase sales
• Shareholder Value: In the long run, owners may gain more from long-term growth than from quick dividend payments.

This article has been a guide to what is Complete Retention. Here, we explain the concept in detail, including its examples and alternatives. You may also find some useful articles here –

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