Glossary

Risk retention is the planned acceptance of losses by deductibles, deliberate noninsurance, and loss-sensitive plans where some, but not all, risk is consciously retained rather than transferred.

The Risk Retention Act (RRA) of 1986 is federal legislation passed in 1986 that authorized the formation of purchasing groups and group self-insurance programs for certain types of liability exposures. According to the Act, members of risk purchasing groups and risk retention groups must be engaged in similar or related businesses or activities.

A risk retention group (RRG) is an insurance company formed pursuant to the federal Risk Retention Act (RRA) of 1981, which was amended in 1986 to allow insurers underwriting all types of liability risks except workers compensation to avoid cumbersome multistate licensing laws. An RRG must be owned by its insureds. Most RRGs are formed as captives and must be domiciled onshore, except for those grandfathered under the 1981 Act.

Risk securitization refers to the use of a debt or equity instrument (security) to finance risk, using a risk index to value the security and/or a specified loss event as a determinant of the interest or repayment date. Risk securities are issued by a special purpose vehicle.

Risk sharing, also known as "risk distribution," means that the premiums and losses of each member of a group of policyholders are allocated within the group based on a predetermined formula. Risk is considered to be shared if there is no policyholder-specific correlation between premiums paid into a captive, for example, and losses paid from the captive's reserve pool.

Used in tax deductibility discussions, risk shifting connotes the transfer of risk to a separate party. In tax disputes, the Internal Revenue Service and numerous courts have required the presence of both risk shifting and risk distribution to find a financial arrangement to be "insurance."

Risk smoothing refers to financing risk in such a way that the financial impact of incurred losses is distributed between members of the risk pool over more than one financial reporting or policy period. Risk smoothing can also be known as chronological stabilization plans.

Risk tolerance refers to the willingness of an organization to incur risk to gain future reward. In insurance, risk tolerance may be evidenced by a willingness of the insured to increase deductibles or self-insured retentions. Alternative risk transfer is used by insureds with low risk tolerance and the corresponding desire to reduce the uncertainty arising from purchase of commercial insurance. Compare to Retention Ability.

Risk types refers to the different ways in which risks are categorized. A few categories that are commonly used are market risk, credit risk, operational risk, strategic risk, liquidity risk, and event risk.

Risk volatility is a measure of the distance between an expected result and its standard deviation. The further this distance, the greater the volatility, and vice versa. For example, expected annual workers compensation losses for ABC Company are $1 million, and the standard deviation is $100,000 (i.e., 10 percent of $1 million). Expected losses for XYZ Company are also $1 million, but the standard deviation is $250,000, or 25 percent of $1 million. Therefore, XYZ Company's volatility is much higher than ABC Company's.