RSK 4803: Risk Retention
advantages of funded risk retention - correct answer-- it is a viable alternative for when there
is not market for that particular risk; or
the risk can not be fully transferred through insurance.
- it may also be less expensive than risk transfer in that:
it has reduced transaction costs;
has a faster claim processing ability with no claim disputes;and
also promotes sound risk control program.
Analyse the steps to implement a retention program
(10 marks) - correct answer-1. Determine the feasibility of the retention fund by:
- determining suitability of the risk financing techniques available for org.;
- classification of risks into insurable and uninsurable, which will reveal the suitability of
funded risk retention;
- evaluate the capacity of org to retain risk and its ability to divert its cash-flow to meet the
losses without significant disruptions.
2. Analysis of the statistical characteristics of the retained risk which involves:
- the analysis of the org. historic loss iot determine loss distribution pattern;
- loss distribution patterns are used to predict the firms future cost of loss. losses with a high
frequency and low severity are usually suitable for retention.
- determination of the probability that the fund will not be sufficient to meet demand by
determine the destruction probability of the fund.
3. Evaluation of the appropriate retention strategy in comparison with other risk financing
techniques
here the org compares the funded risk retention with other alternative risk financing
techniques of insurance
the total cost of risk of the retention strategy is compared with that of insurance with the
intention of determining the optimal trade off between retained risk and risk transfer.
4. lastly once decision has been taken then the appropriate fund retention facility must be
determined. the org may create an internal fund or create a captive insurance company.
Discuss the criteria for evaluating the quantum of retention funding (10 marks) - correct
answer-- the effectiveness of a retention fund is affected by the effect that the fund has on
the value of the firm
- the test is should the funding have a more positive effect on the value of the firm than other
forms of financing, then it must be preferred;
1. value of firm:
-Value of the firm is the the sum of the value of the operations and the value of the
investments.
the value of the firm is affected by size of the fund, the transaction costs and the cost of
capital.
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