When a motor carrier strategizes how to manage its risks, one of the focuses is on preventing and mitigating potential losses. However, part of this planning may also involve deciding which risks they are willing to retain versus those they will seek to transfer (e.g., insurance). Retained losses can directly impact a motor carrier’s financial health and resilience. This type of loss represents the last topic in our four-part series on the total cost of risk.
WHAT ARE RETAINED LOSSES?
When an incident occurs, such as a vehicle accident, retained losses are the portion of a motor carrier’s loss that is not transferred to insurance or other risk transfer mechanisms. Instead, these losses are retained or absorbed by the motor carrier, typically through reserves, cash flow, or other internal financial resources. In other words, retained losses represent the cost a motor carrier decides to bear on its own rather than outsourcing that risk to an insurance provider or other risk-sharing entity. These retained costs can arise from various scenarios, such as:
- Deductibles — The amount paid out of pocket before insurance coverage applies.
- Self-Insured Retention (SIR) — Similar to a deductible, it typically involves greater amounts and often has additional administrative implications.
- Uninsured Losses — Losses not covered by insurance.
THE ROLE OF RETAINED LOSSES IN RISK MANAGEMENT
Retaining losses rather than transferring them is one critical component to a motor carrier’s risk management strategy. This decision may require balancing potential costs against available resources and the company’s risk tolerance. For example, retaining some losses can help avoid high insurance premiums, control claim management, and foster a more proactive approach to managing minor or predictable losses.
However, retained losses may introduce a level of financial risk that can strain a company’s resources if not managed properly. Therefore, it is important to carefully assess how much risk you can absorb without jeopardizing operations, profitability, or growth objectives.
CALCULATING AND FORECASTING RETAINED LOSSES
A crucial part of managing retained losses may involve accurately forecasting potential costs. Estimating these losses can be complex, as it may require evaluating the frequency and severity of potential incidents. Companies may use historical data, industry benchmarks, and statistical models to estimate these factors.
- Loss Frequency — The number of times a loss event occurs, such as a parking lot accident or a slip, trip, or fall injury in a given period.
- Loss Severity — The potential financial impact if an event occurs. For example, a multi-vehicle accident could lead to high-severity losses if severe injuries or property damage occurred.
- Risk Tolerance — The level of risk the company is willing to accept without insurance. The company’s financial capacity to absorb losses and operational flexibility often inform this decision.
When companies analyze these factors together, they can make informed decisions about the amount of loss they are comfortable retaining. Businesses often establish a threshold, referred to as a retention level, to define the amount of loss they are prepared to absorb within a given period.
THE COSTS ASSOCIATED WITH RETAINED LOSSES
Retained losses are not just straightforward costs; they can include direct and indirect expenses that businesses should consider:
- Direct Costs — These costs may be easier to predict and budget for, such as tow bills and revenue lost because of a rejected load.
- Indirect Costs — These costs are harder to predict and may be more substantial, such as lost productivity, reputational damage, and legal expenses.
FINANCING RETAINED LOSSES
Motor carriers should have a robust plan to finance retained losses to cover these costs without disrupting operations. Some common approaches include:
- Reserves — Allocating specific funds to cover anticipated losses. This approach can help ensure financial resources are available when needed, though it also ties up cash that could otherwise be used for investment.
- Captive Insurance — Joining a captive insurance subsidiary to underwrite some of the company’s risks. Captives can allow companies to benefit from a self-insurance model while still benefiting from some formalized risk management structure.
- Lines of Credit — Establishing credit facilities that can be accessed quickly to cover unexpected costs. While this provides flexibility, it can add interest costs and potential debt burden.
As you plan your risk-management strategy, consider the pros and cons of retaining losses, as well as the other costs associated with risk transfer, risk control, and administration.
The information in this article is provided as a courtesy of Great West Casualty Company. To see what additional resources Great West Casualty Company can provide for its insureds, please contact your risk control representative, or click below to find an agent.
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