Download - Risk financing
Objectives
Define risk financingDescribe each of the risk financing
techniquesDifferentiate between first party and third
party insurance.Explain the difference between claims-made
and occurrence insurance.Discuss the cost of risk.Compare a soft market and a hard market.
Basics of Risk Financing
Encompasses all ways of generating funds to pay for losses that risk control techniques do not entirely prevent.
Designed to obtain funds, at the least possible cost, to restore losses that strike the organization and assure post-loss financial resource availability
Significance of the Distinction BetweenRisk Control and Risk Financing
An organization should apply at least one risk control and at least one risk financing technique to each of its significant loss exposures unless exposure avoidance is a practical and safe alternative.
One risk control technique often may be substituted for another; one risk financing technique often may be substituted for another.
Risk Financing Techniques
Risk Retention– Current expensing of losses– Unfunded loss reserve– Funded loss reserve– Borrowed funds– Self-insurance Self-insurance trust Affiliated, captive insurer
Risk Financing Techniques
Risk Retention (cont.)– Current expensing of a loss
Charging off losses as current expenses without a fund or reserve; paying for losses out of available cash as they occur.
Acceptable for losses that are small in nature and infrequent in occurrence
Example: deductible for automobile or property loss
Risk Financing Techniques
Risk Retention (cont.)– Unfunded loss reserve An accounting entry that shows a potential
liability, segregates a portion of surplus equal to booked value of retained losses
ExamplesUncollectible accountsLoss of revenue for lost items (dentures,
eye glasses, hearing aides, etc.)
Risk Financing Techniques
Risk Retention (cont.)– Funded loss reserve Organization sets aside funds (cash, securities,
or other liquid assets) for expected losses, i.e., “earmarked funds”.
ExamplesReserve for taxes payable at the end of the
monthReserve to absorb the cost of defending
claims
Risk Financing Techniques
Risk Retention (cont.)– Borrowed funds An organization borrows to pay losses Results in a reduction in its line of credit or
ability to borrow for other purposes Represents a depletion of its own resources
to pay its losses and, in time, uses its own earnings to repay the loan
Risk Financing Techniques
Risk Retention (cont.)– Self-insurance trustA funding vehicle that is a bank account
administered by an independent third party (trustee).
The funds are designated for the sole and restricted purpose of paying losses.
Risk Financing Techniques
Risk Retention (cont.)– Affiliated, captive insurerA subsidiary to finance specified types of
losses.Generally, the affiliated insurer and the insured
“parent” organization are members of the same “economic family,” negating any transfer of risk to an outside entity.
Corporation for which the product is the payment of losses and the revenue is premium payments.
Risk Financing Techniques
Risk Retention (cont.)– Affiliated, captive insurerHighly formalized type of retention Types of captivesSingle parentGroup captives
Risk Financing Techniques
Risk Transfer– Definition: transmit an organization’s risks
to an outside party.– Funding the payment of losses from outside
the organization after a specified loss.– Contract or provision of a contract.– Commitment to pay.– Organization can transfer the financial
burden of losses but not necessarily the ultimate legal responsibility for losses.
Risk Financing Techniques
Risk Transfer (cont.)– Noninsurance A contract under which one party, the
transferee/indemnitor, agrees to pay money for specified types of losses for which, in the absence of the contract, the financial burden would fall on the transferor.
Risk Financing Techniques
Risk Transfer (cont.)– InsuranceInsurance is a system by which a risk is
transferred to an insurance company, which reimburses the insured for covered losses and provides for sharing costs of losses among all insureds.
Risk Financing Techniques
Risk Transfer (cont.)– InsuranceA contractual relationship that exists when one
party (the insurer), for a consideration (the premium), agrees to reimburse another party (the insured) for losses to a specified subject (the risk) caused by designated contingencies (hazards or perils).
Risk Financing Techniques
Key Variables to Consider in Selecting Techniques– Size and type of organization– Financial strength and resources of the organization– Type of risk to be treated– Organization’s risk-taking philosophy– Organization’s goals and objectives– Effectiveness of the risk management and loss
control program– Effect each technique has on the organization’s long
run costs and, therefore, on its profitability
Insurance Contract
Insurance policy is a legal contract– Standard elements Declarations page Insuring agreement Conditions Exclusions
Insurance Contract
Direct insurance is a contractual arrangement involving, the purchase of insurance by an “insured” from an “insurer”
– Primary insurance is the first layer of coverage, the layer that is prone to loss
– Excess insurance sits over specific primary insurance to afford additional limits of liability
Insurance Contract
Reinsurance– Reinsurance is a contractual arrangement involving
the purchase of insurance by an “insurer” from “another insurer”
– Risk sharing reduces ultimate loss exposure to a more comfortable level Stabilizing effect - smoothes the ups and downs of
fluctuating loss experience Increases capacity Catastrophic protection - protects against the
adverse effects of large losses from natural forces or man-made disasters
Insurance Contract
Terms and Conditions of Limits of Liability– Policy limit - represents the maximum amount
the insurer will pay for losses– Per occurrence - applies to a specific loss– Aggregate - applies to all losses within a
policy term– Defense costs can be included within the
policy limitor outside
Types of Insurance
First party– Provides coverage for the insured’s own
property or person so that the insured will be restored to the same financial position that he or she had prior to the loss.
Types of Insurance
Fire/propertyBusiness interruptionBoiler and machineryBuilder’s risk
Crime Electronic data
processing and mediaemployee dishonestyFlood Earthquake
Types of Insurance
Third party – Synonym for liability insurance – Provides coverage to a party other than
the insured to make that person whole for loss or injury covered by the insured.
– Involves three partiesOne who is harmedThe insured who caused the harm or damageThe insurer
Types of Insurance
Medical professional liability
General liability (premises liability)
Umbrella excess liability
Employment practice liability
Automobile liabilityGarage/
garagekeepers’ liability
Directors and officers’ liability (D&O)
Errors and omissions (E&O)
Environmental impairment liability
Fiduciary liabilityHeliport and non-
owned aircraft liabilityEducational and child
care center.
Insurance Market
What is the current market?– Soft market: characterized by low premiums,
flexible terms, and generous capacity– Hard market: characterized by escalating
premiums, strict underwriting procedures, and limited availability of coverage
Cost of Risk (COR)
The value of all risks, internal and external, faced by an organization in fulfilling its mission.
The development of insurance budgets, the value of an organization's liabilities reported on the audited financial statements, and the effect of COR in continuing a specific clinical service are good examples of the use and impact that COR can play in managing a health care organization