BU353 Chapter Notes - Chapter 7: Transaction Cost, Public Company, Discounted Cash Flow
Document Summary
Risk retention the decision to accept the uncertainty associated with a particular risk exposure. Risk reduction the decision to reduce uncertainty. The alternative to retention is to reduce risk using an insurance contract. Benefits of increased retention: savings on premium loadings, reducing exposure to insurance market volatility, reducing moral hazard, avoiding high premiums that may accompany asymmetric information. The ability to save on some of the admin expenses and profit loadings in insurance premiums, thus reducing the expected cash outflows for these loadings. Specific sources of savings include lower commissions to insurance brokers, savings in premium taxes. The savings on premium loadings depend on the insurer"s cost of providing these services relative to the firm"s own costs. Potential savings in profit loadings also can depend on the degree of competition in insurance markets. When moral hazard is more of a potential problem, firms tend to retain more risk.
