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The risk library  /  Reserves and return

Art. 22 · Reserves and return · 3 min read

Idle capital has a cost

Self-insurance is not free. Its price is the return you give up on money that has to stay available, and that price is easy to miss because nobody invoices you for it.

Say you hold £250,000 against risk, in the current account, earning nothing. Prices rise 3% over the year. At the end of it the statement still says £250,000 and you can buy about £242,700 worth of the things that reserve exists to buy: rebuilding, replacement plant, contractors, wages.

Nothing was spent. £7,300 of capacity disappeared anyway.

£250,000: what the statement says £215,700: what it can actually buy after five years £34,300 of capacity, gone year 0 2 4 5 Assumes 3% inflation and no interest. Illustrative.
Fig. 24 · The reserve did its job perfectly for five years and still lost a seventh of its power. This is the cost of self-insurance that never appears in a comparison against a premium.

This matters for the comparison at the heart of Part IV. When you weigh "keep the risk" against "transfer the risk," the honest cost of keeping it is the expected losses plus the return foregone on the capital that has to sit there ready. Leave the second term out and self-insurance always wins on paper.

It also matters because the liability inflates too. If rebuild costs are rising at 6% and your reserve is earning 1%, the reserve is falling behind at 5% a year even though the balance is technically growing. A reserve is only adequate relative to what it has to buy.

None of this is an argument against holding reserves. It is an argument for the reserve being invested appropriately rather than left idle, which raises the question of what "appropriately" means for money that might be needed at three days' notice. That is the next two articles.

Use it

  • Add the carrying cost to your comparison. Expected losses plus foregone return is the real price of retaining risk.
  • Check what your reserve is earning. Many business current accounts pay nothing. Instant-access business savings and money-market funds exist and take an afternoon to arrange.
  • Index the reserve to what it buys. If it exists to fund rebuilding, revisit its size when construction costs move, not when you happen to think of it.

Want this run against your own numbers?

We put ranges, not single figures, against the risks your business actually carries.

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Explanatory content only. This article describes how insurance and risk decisions work in general terms; it is not insurance, legal, actuarial, or investment advice, and it is not a recommendation to buy, keep or cancel any cover. Every figure and diagram is illustrative, chosen to make a mechanism visible, not to describe any particular business.