Chapter 4 risk financing

Total Cost of Risk

-Expected cost of losses: Indirect - Additional Living Expense, Business Interruption Direct - Property damage, liability judgements expenditures of risk mgmt (Administrative, Risk Control, Risk Financing) Residual Uncertainty -impact on financial stability and reputation

Current expensing of losses

-retention funding option- Least formal/cheapest measure; relies on current cash flows to meet costs of loss.

unfunded reserve

-retention funding option- Estimate of cost shown as an accounting entry; no assets immediately available to pay

funded reserve

-retention funding option- Formal or Informal (identifying which assets could be sold to meet a loss obligation)

borrowing funds

-retention funding option- Line of Credit or negotiated loan

why form a captive

1)Reduce premium costs 2)Control insurance destiny 3)Access reinsurance market 4)Control cash flow 5)Create capacity 6)Tax Strategy

Large deductible plan

An insurance policy with a per occurrence or per accident deductible of $100,000 or more.

retrospective rating plans

Deposit premium is paid up-front Premium adjusted at end of term based on current policy period loss experience Involves a negotiated loss limit Typically less expensive than self-insurance

insurance pool

Group of companies band together to insure each other Economies of scale

Institutions with Captives Include:

Institutions with Captives Include: Delta & US Airways Duke Energy Bank of America Sears Catholic Church Coca-Cola UPS CBS Corporation Avis Georgia Pacific AT&T and VerizonBoeingLehigh Valley HospitalPlus 7,000 other companies

Advantages of Retention

Insurance premium cost factors are saved Direct control of the Claims Process Timing of Cash Flows ----Avoids paying the up-front cost of insurance, and then waiting for claims payment Increased incentive for Risk Control

All of the following about captive insurers are true except:

May increase volatility of firm's earnings

insurance policy layers

Retention layer (deductible) Primary Layer Excess Layer (Umbrella Policy)

Protected Cell

Similar to Rent-a-Captive, but insured entity receives credit for underwriting profit and investment income (each participating company owns an entire cell).

hold-harmless agreement (Non-Insurance Transfer)

Transfer loss exposure to other party -separate contract ****ex. lease or construction agreement

Self- insurance

a special form of planned retention by which part or all of a given loss exposure is retained by the firm -paying for losses as they happen with current cash flow. includes: Recordkeeping, Claim Adjustment, Loss Reserving, Litigation Management, Regulatory Requirements, Excess Coverage Insurance

securitizaiton

a system where a pool of loans is assembled and shares of that pool are sold to investors

captive insurer

an insurer owned by a parent firm for the purpose of insuring the parent firm's loss exposures single parent captives are called pure captives Separate company is created Can be used with hard to insure risks Can insure 3rd party business

the least efficient and most expensive retention program is:

borrowing

above $1 million is called:

excess insurance

most appropriate risk financing measure

high severity/low frequency --Transfer high/high-- avoid -Organization Characteristics- Risk tolerance Financial condition Ability to diversify loss exposures Ability to control losses Ability to administer retention plan

Guaranteed Cost Insurance

insurance policies in which the premium and limits are specified in advance

Cost of risk includes all of the following except

insurance recovery

Risk Retention Group

insures liability exposures ***(medical malpractice)***

Risk Exposures Covered By Captive

liability coverage property risk workers compensation

Retention

means that the firm retains part or all of the losses that can result from a given loss retention lvl is dollar amount a firm can retain. Anything below the deductible is retained by the insured

Contractor required to sign a Hold Harmless Agreement is an example of?

non-insurance transfer

Rent-a-captive

organization rents capital from a Captive, which provides insurance

risk financing

providing payment of losses after they occur, making sure funds are there when needed. goals- 1)manage expenditures on risk mgmt (and costs, risk control expenses, risk financing expenses) 2)maintain appropriate level of liquidity (cash is required to pay for retained losses) 3) comply with legal requirements

The best automobile collision loss retention program for Swift & Co. with 5,000 company owned vehicles is:

self insurance