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Risk Financing Options (Goal (internal fund (retention), external fund…
Risk Financing Options
Goal
internal fund
retention
external fund
transfer
borrowings $
issuing debt
alternative risk financing mechanisms
Risk Transfers of the Financing Type
seek funds
unrelated 3rd parties
still exposed to losses
transfer FR
to 3rd party
insurance
non-insurance risk transfers
leases
tenant is FR when occupying
hold-harmless agreement
contractor
FR for all L. losses
can return to the firm/individual
Retention
Individual ex
not buying ins.
underinsured
insurance with deductible
active/ passive
fund
funded
separate; pay from the account
high (F)
more predictable; higher in S
unfunded
not separate fund
current CF
borrowed fund
low (S); low (F)
Self- insurance
active; funded
formal self-ins. program
health ins.
employ benefit plan
workers compensation
characteristics
predictable if firm's large
long payout period(long tail pattern)
pre-funding the Known lose in the future!
Adv of SI v.s. Market Insurance
less expensive
expected cost of SI<Known cost of MKT ins.
savings
no risk charge (no explicit risk but still estimation risk)
no marketing expenses
no distribution expenses
no state premium taxes
could be invested internally
high ROR
retain the benefit
loss prevention/reduction
reduce the moral hazard
cost of risk impact reduces
health insurance
no. 1 reason
ERISA state mandate
Employee Retirement Income Security Act
Dis. of SI. V.S. Market Insurance
Pos. of a catastrophic loss
buy stop-loss ins
contract- large deductible
adm. activities associated with ins.
buy ASO from an insurer
adm service only
TPA
third party adm.
public relations problems
when denying claims
Captive Insurer+Risk Retention Group (RRG)
hard market ins.
captive ins.
reinsurance market
RRG
high risk
cabs;emergency response vehicle; school bus
satisfied any legal requirement
risk control
overall cost of risk decreases