Risk MGMT ch 4

Advantages of Retention or a "deductible"

-Insurance premium cost factors are saved: (Pure loss costs plus expense loads, Premium taxes, Social loading costs (NC Reinsurance Facility - JUA), -Adverse selection loading costs) -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 -Reduce the cost dramatically

Risk Financing Goals

1. Pay for Losses 2. Manage Expenditures on risk Management 3. Maintain Appropriate levels of Liquidity 4. Comply with Legal Requirements

Total Cost of Risk

= Expected cost of Losses + Expenditures on RM + Residual Uncertainty

Manage expenditures on RM

Admin costs, risk control expenses, and risk financing expenses

Maintain Appropriate Levels of Liquidity

Cash is required to pay for retained losses a good risk financing program will help you manage cash reserves

Admin Costs

Cost of internal administration, or risk management consulting

Risk Control Expenses

Costs to reduce frequency & severity or increase predictability

Retention Funding Options

Current Expensing of Losses, unfunded Reserve, Funded Reserve, or Borrowing Funds

Loss Exposure Characteristics (Risk Matrix)

High Severity/Low Frequency = Transfer High Severity/High Frequency = Avoid

Cost of risk includes all of the following except: Insurance premiums Retained losses Insurance recovery Loss control expenses

Insurance recovery

borrowing funds

LOC or negotiated loan expenses higher due to interest paid

Comply with Legal requirements

Laws sometimes require individuals and businesses to purchase certain insurance products (ex: personal and commercial auto insurance, Workers Compensation)

Current Expenses of Losses

Least formal *cheapest* relies on current CFs to meet costs of loss "self insurance" = <50 employees ex: workers comp

Selecting the most appropriate risk financing measure

Mix of retention and transfer, loss exposure characteristics, and the organizations characteristics

Under the selection process of the RM Decision making Process, this is a technique consistent with a company's risk appetite

Risk Financing

The least efficient and most expensive retention program is

borrowing

Risk Financing Expenses

costs to manage risk financing measures (broker fees, bank fees)

Mix of retention and transfer

depends on the ability to pay, and the goals of the individual or organization

unfunded reserve

estimate the cost shown as an accounting entry no assets immediately available to pay *recognize as a liability*

funded reserve

formal or informal (identifying which assets could be sold to meet a loss obligation) *set up a reserve*

Pay for Losses

make sure that funds are there when needed, and also includes transfer costs (insurance premiums, cost to hedge an investment, etc. )

Retention and transfer

the two main approaches to risk financing . For most risks, a combo of both is needed. *Anything below the deductible is retained by the insured.* Consider a continuum Slides 7-9 on PPT

Organization Characteristics

what risk managers decide, set up retention program based on this: Risk tolerance Financial condition Ability to diversify loss exposures Ability to control losses Ability to administer retention plan