January 28, 2016
What is Alternative Risk Financing?
Before the 1980s, businesses had the choice of two different traditional methods for risk financing. They could purchase an insurance policy and allow the insurance company to absorb the cost or they could choose self-insurance, which required them to take company funds and allocate them so that they could meet any expected (or unexpected) losses. In the 1980s, however, this system changed. Many companies found that they could not find commercial insurance coverage. Rather than put their business at a higher risk by choosing self-insurance, companies began to consider alternative risk management.
Types of Alternative Risk Financing
If you choose not to use one of the more traditional methods of risk financing, the good news is that there are a number of other options available. This section will give a brief definition of most of these options.
A captive is a type of insurance company that protects a parent company and its entities from costs related to property and casualty. They are often the choice of companies who are whole enterprises, for which more traditional commercial insurance is either too expensive or unavailable. There are a number of different structures available for this type of arrangement.
Risk Retention Group
Risk retention groups are made up of organizations and people that engage in the same type of business, which allows them to have the same liabilities. These groups and people come together to create an entity- if you have a membership, then you are also an owner. This allows companies to access the markets for reinsurance so that they have stable coverage at a reasonable rate.
Risk Purchasing Groups
Unlike the previous option, a risk purchasing group allows unassociated business to come together. If any of these members have similar risk profiles for their company, they can take advantage of purchasing insurance together. This allows them more affordable rates and access to insurance plans that they may not have had otherwise.
Large Deductible Plans
A large deductible plan involves an insurance company, like Oros Risk, and several companies that purchase the plan. The individual companies pay a premium that is tax deductible. The insurance company then retains the money and assumes liability for insurance claims.
Loss Portfolio Transfer
In this type of transfer, liabilities are transferred to a reinsurer. This allows liabilities to be removed from the balance sheet and transfers both investment risk and timing risk. It also transfers reserves to cover those claims, in excess of what is currently owed. As losses are incurred, the reinsurer must cover those. The benefit is that the reinsurer retains the excess payment though they may also lose money if the repayment takes longer than expected.
Integrated Risk Programs
Integrated risk programs typically offer insurance for a period between one and three years. The major advantage of these is that they are customizable, meaning that you do not pay for insurance options that you do not need. They are also very stable because you are locked into the same rate, limits, terms, and conditions, regardless of claims that may arise.
Another popular option for some companies (especially those located in a potentially dangerous area) is catastrophe bonds. These are bought (and also sold) in capital markets. These package the risk associated with catastrophe as a security. This security can be transferred between owners.
This is by no means an all-inclusive list of alternative risk retention options. There are a number of other alternatives that can absorb risk, as well as several products that can help reduce risk and the associated costs. You should choose the risk management plan for your business wisely- carefully evaluate the advantages, disadvantages, and costs of each before making your decision.
Lautaro Martinez, a freelance writer, enjoys sharing tips and insights business safety. If you would like to learn more about Lautaro, you can check out his google+ profile