What does Risk Retention in real life look like?

The term ‘Risk Management’ in itself is so vast that there are experts and researchers round the globe who are devoting their entire lives towards this discipline. Indeed this blog can by no means justify the content of Risk management, rather it is aimed at a very particular subject of “What does Risk Retention in real life look like?” It emphasis on the very aspect that majority of the work and research is being carried out for trying to navigate in the financial aspect associated with risk management. People want to learn this subject with an aim either to minimize their potential chances for loss/ maximize gains or to be able to make more informed decisions while investing (be it their own money or their stakeholders) by taking into account various contiguous factors.

However, the very basics of this subject are been forgotten by majority of people. Either it is being neglected at mass level or not many are intrigued by the intricacies involved with it. That being said, in order to further continue on this joy ride it is important for the readers to understand the Methods of Handling Risk, following is the structure of Methods of Handling Risk provided by William C. Spaulding (William, 2019):

For purpose of brevity, I would try to cover only the tip of the ice-berg of the behemoth pillar of ‘Risk Retention’

So, what exactly is risk retention?

“Risk retention, (aka active retention, risk assumption), is handling the unavoidable or unavoided risk internally, either because insurance cannot be purchased or it is too expensive for the risk, or because it is much more cost-effective to handle the risk internally.”

To put it simply “Efforts made in order to reduce the potential damage from risky elements existing in the environment around you.”

So now a question must have risen in the minds of readers, what do I have to do with Risk Retention? What purpose does it serve to me? What help will it be to me in my professional life? Should I read it any further, it is getting all bookish!

Well, wait, wait, wait….! Just wait for the real-life (my personal) situation I am about to share with you, maybe after that you might have a change of mind and heart?

The Scene:

I was on an audit assignment (read my first blog, “What is this Audit Debacle all about?” if in case you forgot what Audit basically is) at a power plant at Pipavav, Gujarat. My audit assignment was limited to the Physical Verification of Inventory and reporting on the Control systems, however, I was also on another assignment of reviewing the Internal Financial Controls of the generator. Both assignments were going on simultaneously and as I was to make the final report, I was the only person who was to be part of both the teams. Our team was grinding in day and night to verify such a huge quantum of variegated spares, tools and materials which had costs ranging from as cheap as Rs. 50/ dozen (for small tapes) to Rs. 50 lakhs (for a single piece of wafer like membrane to be used in machines for controlling the entire plant), all under a single roof! When we were verifying the Inventory, there were a bunch of foam-based cleaners which were conveniently placed atop the spares of the turbines, the foams were meant for cleaning of those spares itself. So what is the issue? Isn’t it great that all the stuff is kept at the right place where it should be? Well ideally it would have been great, however, while moving it around my eyes caught upon the disclaimer and hazard symbols placed on the small spray containers, it read highly flammable if kept for extended period in dry and hot temperature exceeding 50° C. Guess what, that day the temperature was about 46° C, saved right? By god’s grace there was no untoward incident at all even when it was at such higher temperatures. But the point was those foam spray didn’t even cost about Rs. 2,000; however, the spares upon which it was placed that was over Rs. 40 lakhs and over Rs. 50 crores of inventory located just around that box, all lying under the same roof! This issue would most probably wouldn’t have occurred if the audit was limited to the Physical Verification of Inventory or per say the review of Internal Financial Controls of the Company as in the earlier case, it would have been out of the scope of audit and in later one it would most probably would have gone unnoticed as more emphasis would have been made on the documentation aspect and review of major processes only.

A catastrophe and the Company would been in serious trouble, it is not that the Company isn’t insured or something, but the point here is, are you willing to risk a Rs. 40,00,000 of material for Rs. 2000 bottle of cleaner? Moreover, there might be chances that while Investigating the Insurers found out the cause and the main culprit being lack/ negligence on part of the Company that they exposed their valuable materials to such risk, the Insurer might even reject the claim or may pass on only a part of the Claim, in that scenario, who is at fault?

The store in-charge for not reading the instructions carefully?

The Management, for not training the employees enough by which employees themselves identify risks and appreciate measures for managing it?

Or is it the Company for not building enough infrastructure for storing materials of different sort at desirable locations?

Well, it is the fault of all but the blame is on none! The store in-charge was doing his job with optimum level of diligence; the management was framing safety procedures and policies and was also training employees so that risk can be minimized and the Company had also spent a sizeable chunk of money by building warehouses and installing fire protection equipment’s. So, individually neither one can be blamed but at an overall level, all failed! The reason to simply put forward, is lack of understanding of Risk Management and risk retention.

Management hires experts to create processes and spends huge quantum of money on implementing and controlling, so why does scenarios like this pop-up? The simple reason being, “Lack of organizational culture towards risk management.” It is quintessential for employers to promote sense of risk of appreciation towards risk management and how each and every ones role is important in managing risk, only that way the organization can actually become risk aversive in true manner. 

The Learning

From the scene as mentioned above the readers might be able to comprehend that there are two ways of retaining risks: 1) Active Risk Retention and 2) Passive Risk Retention. Active Risk Retentions is the phenomenon of retaining the risks after duly identifying all the risks and potential impacts (outcomes) to be faced by the organisation at the event of risk not being transferred/ insured elsewhere. Whereas, Passive Risk Retention is when the organisation retains risks unknowingly i.e. without actual identification of risks is being carried out. It is pretty obvious that retaining of risks without even knowing about it is really harmful not only to the organisation but at times to the society at large too, so it is imperative for risk managers to evaluate the processes framed within the organisation with an exhaustive approach so that the probability of passive risk retention is minimalized.

Also, we understood that Risk retention is not only about a text book terminology and neither it is limited to investment related activities, it is the pillar on which your business functions, and it is there when your business breathes its first breath and will end when your business takes its last one. It will be present at each and every moment, so it’s upon you to decide how alert and aversive you would like to be! It depends on your willingness to let the environment surrounding you take a toll on your business by ignoring basic aspects of safety and attitude or your willingness to thrive and become a great sport to your competitors!

References

William, S. C. (2019). Handling Risk. Retrieved from thismatter.com: https://thismatter.com/money/insurance/handling-risk.htm