uum-bwrr3033: risk management-chapter 08 risk financing

7/27/2019 UUM-BWRR3033: Risk Management-Chapter 08 Risk Financing

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Contents The cost of risk financing

Traditional financing methods

Selection of deductibles

Non-traditional financing methods (ART)

Finite risk insurance

Retrospective plan Captive Insurer


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Learning ObjectiveAt the end of this chapter, student should be able to:

calculate the costs of risk financing

distinguish between traditional and nontraditionalfinancing methods

Identify the different types of deductible and theimplications of the selection

Differentiate between stop loss provision and aggregatedeductible

Apply deductible selection models

Describe examples of specific types of ART products


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Cost of risk financing Risk retention

Expected loss

Opportunity cost on loss reserve

Risk transfer (to insurance co)

Expected loss = loss premium Premium loadings

Management expences


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Advantages of Risk Retention Business can maintain use of funds until a real loss

occurred.

Business can avoid swings in insurance prices. Notaffected by underwriting cycle (that would lead to the

higher insurance premium)

Save on premium loadings

Can avoid high cost on premium loadings


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Traditional Method of Risk

Financing Common character

Premium is fixed

Premium is not sensitive to losses Significant amount of risk transferred to insurer


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Financing Deductible / Self- Insured Retention: Certain amount

of loss will be retained by policy holder

To eliminate small claim

To reduce premium

To reduce moral/morale hazards

1. Per occurrence deductible: Certain amount beretained by policy holder on each claim.

2. Aggregate deductible: Policyholder retain lossesin accumulation until the specific amount.

3. Stop-loss provision:Combination of (1) and (2)


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Financing Policy limit:maximum amount payable by insurer.

1. Per occurrence limit: maximum amount of claimpayable on each loss that is covered.

RM3m coverage per occurrence above RM1m of per

occurrence SIR.

2. Annual aggregate limit:maximum amount ofclaim payment in accumulation in which insureris liable during the policy period.

RM3m of annual aggregate limit above RM1m of peroccurrence SIR


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Financing In annual aggregate limit policy, insurance policy will

be terminated when the full amount of sum insured

has been paid within the policy period. Policyholder has to bear own loss unless they have

purchased another insurance policy


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Financing Types of excess insurance policy:

Primary policy

provide coverage immediately above SIR Layering policy

provide coverage above primary policy

Umbrella policy

provide coverage above primary policy and layering

policy

Normally covering liability policy


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Non-traditional Risk Financing

(Alternative Risk Transfer) Common characteristics:

Transferring extremely high risk to insurer

Policy covering more than 1 year (Ex: Contractor AllRisks)

Policy provides multiple sources of risk.

Un-common risk


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3 ART methods:1. Loss sensitive contract (Risk: insurer < policy holder)

Experience-rated policy : premium for coming

policy year is based on the pass loss experience ofindividual policyholder.

Retrospective-rated policy : ultimate (retro)

premium is charged at the end of policy period.

if actual loss less than expected loss, the retro premium is

less than upfront premium. Policyholder entitled for

refund.


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3 ART methods:2. Finite risk contract

Multiple-year loss sensitive contract

Policyholder need to pay premium for n years to the

insurer.

Insurer will charge a fee

The premium fund is invested and accumulated interest.

On any claim, the fund is used to pay the claim. If insufficientamount, insurer will pay upfront. The following yearpremium will repay insurer.

At the end of n-year, if there is surplus, it will be refundedto policyholder. If deficit , policyholder need to pay certainportion in equal instalments over few years.


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3 ART methods:3. Captive Insurer

Insurance company as subsidiary of parent

company. Pure captive insurer Vs Group captive insurer

Onshore captive insurer Vs Offshore captive

insurer

uum-bwrr3033: risk management-chapter 08 risk financing

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