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The risk library  /  What your balance sheet can absorb

Art. 18 · What your balance sheet can absorb · 3 min read

Setting your own bar

Every risk decision downstream depends on one number that no analysis can produce for you: how bad a year you insist on being able to survive.

There is no objectively correct answer. A family business with no debt and patient shareholders might be comfortable saying "we should survive nineteen years out of twenty, and the twentieth would hurt." A business with bank covenants and a refinancing next year may need to survive 199 years out of 200.

Those two businesses should buy completely different insurance, hold completely different reserves, and set completely different excesses, from identical risks.

Your bar A stated probability that you will get through the year without the cost of risk doing real damage. Everything else follows from it: reserve size, excess levels, which limits to raise.
a typical year £50k 1 year in 10 £122k 1 year in 200: past the edge of this chart £0 £50k £100k £150k £200k WHAT A YEAR OF RISK COSTS THIS BUSINESS
Fig. 20 · Illustrative distribution: most years are cheap, and the average is dragged upward by years you will rarely see. Note where the marks sit. Getting from "survive a typical year" to "survive a one-in-ten year" costs some money. Getting from there to one-in-two-hundred costs a great deal more, because the tail is long. That steepness is why the bar has to be a deliberate choice.

Two practical points. First, most businesses already have an implicit bar. It is just unstated, never examined, and wildly inconsistent between risks. They will insure a £40,000 van to the pound and carry a £3m liability exposure on a £1m limit.

Second, the bar interacts with time. Surviving one bad year is a different requirement from surviving two in a row, and consecutive bad years are less rare than people assume.

Use it

  • Say it out loud and write it down. "We intend to be able to absorb the worst year in twenty without external help." One sentence, at board level.
  • Check every cover against it. Inconsistencies will show up immediately, and they are usually the cheapest thing to fix.
  • Revisit it when the balance sheet changes. New debt, a big contract or a weak trading year all move the bar, and none of them will prompt a review on their own.

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.