How is risk retention best defined in insurance terms?

Risk retention is best defined as a method of taking on risk as a financial responsibility instead of transferring it to an insurer. This concept entails that an individual or organization accepts the financial consequences of certain risks, effectively choosing to handle or absorb those risks rather than shifting them to an insurance company.

In practice, risk retention often comes into play when the cost of insurance coverage exceeds the potential loss from a risk, or when the entity feels it can manage the risk more effectively than an insurer would. For example, a business may decide to retain certain risks that are low in frequency or severity, opting to pay out-of-pocket for minor claims that fall below a predetermined threshold rather than incurring the cost of insurance premiums for coverage.

Understanding risk retention is essential, especially in risk management strategies, as it helps entities balance their risk profiles and financial responsibilities. This allows them to allocate resources to more significant risks or areas where insurance provides better value or efficiency.