Risk Financing The Principles of Utilizing Insurance Resources Peter Wang

Index Introduction Types of Risk Financing and its Techniques Considerations Principles of Utilizing Insurance Resources

Risk Financing A risk management tool of financing the loss by way of Transfer Insurance Non-insurance Retention Deductible Self-insurance Captive Banking Arrangement

Type of Risk Financing by Way of Funding Arrangement Prospective Risk Financing Contemporaneous Risk Financing Retrospective Risk Financing

Risk Financing Techniques (1) Transfer or Mostly Transfer Techniques Guaranteed Cost Insurance Experience-Rated Insurance Retrospectively Rated Insurance 100% Transfer 100% Retention

Risk Financing Techniques (2) Transfer / Retention Techniques Consumer Cooperatives Self-insurance Pools Risk Retention Groups Administrative Services only (ASO) 100% Transfer 100% Retention

Risk Financing Techniques (3) Retention or Mostly Retention Techniques Captive Insurers Finite Risk Plans 100% Transfer 100% Retention

Captive Insurer An entity formed primarily to insure or reinsure the business risk of the parent organisation.

Captive Insurer Reinsurance Markets Captive Reinsurance Broker Business Units Local Insurer Business Units Broker

Finite Risk Plans

Illustration of Spread Loss Cover Each and every loss US$125,000 Each and every loss limit US$9,875,000 Annual Aggregate Limit US$9,875,000 Annual Base Premium US$2,000,000 Annual Insurer’s expense US$200,000 (10% 0f Annual Base Premium) Adjustment Premium 30% of any Commutation Account Deficit Five years Period YearPremium (US$)Expense (US$)Loss To Cover (US$) Year End Commutation Balance (US$) 20062,000,000200,000125,0001,675, ,000,000200,0003,475, ,000,000200,0008,250,000(2,975,000) 20092,892,500200,000(282,500) 20102,084,750200,0001,602,250

Considerations Affecting Choice Between Retention & Transfer Loss Frequency & Loss Severity Capacity for Bearing Loss Degree of Control Loading Fees, Financial Service Fees and other Transaction Costs Value of Services Provided by Insurers & other Financial Institutions Opportunity Costs Tax Consideration

Principles Reduce the total cost of risk to the minimum Maximize protection in the most cost effective way Transfer risk to party with sound security & professionalism

Total Cost of Risk Administrative Cost for Risk Management Risk Control Cost Uninsured Losses Insurance Premiums

Insurance Resources Insurers Pricing Security Intermediaries Insurance Brokers (work for the benefit of clients) Insurance Agents (work on behalf of insurers) Others Risks Engineers  Risk Control Loss Adjusters  Loss Assessment

Pricing (1) How Insurers view the risk Catastrophe Risk Banking Risk Working Risk Low frequency high severity Less frequent loss events Loss to be recoverable by higher premium normally over 3~5 years High frequency low severity   

Pricing (2) The Insurance Market Cycle

Pricing (3) Supply & Demand P D S Q 0

Security Causes of Insolvency Under-reserving Insufficient Capitalisation Rapid/Excessive Growth Poor Underwriting Inadequate or Failed Reinsurance Protection Over-valued Assets Investment Errors Management Quality Economic and Political Problems

Insurers Review Non-Financial Review Reputation Local Regulation Ownership Payment Record Added Value Service

Insurers Review Financial Review (1) Solvency Assessment Financial Performance

Insurers Review Financial Review (2) Key Index Usual Range Loss Ratio (loss incurred/premium earned)< 65% Expense Ratio (underwriting expense incurred/premium written) < 35% Combined Ration (Loss Ration + Expense Ratio)< 100% Operating Ratio (Combined Ratio – Net Investment Ratio) < 100% Solvency Margin (Net premium written/surplus)< 300% Net premium written/Gross premium written> 50% Growth Ratio of retained premium-10% to 33%

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