Financing Of Risk - Crm

Front 1

Feasibility Determination FIRST STEP in Development Process of a Captive

Due Diligence, study factors justify the formation can they remain solvent.

Back 1

Study TCOR, business plan, loss projections, 3-5 yrs financials, structure, identify service providers, tax considerations, establish domicile recs - group members must provide detailed financial info and commit to join

Front 2

Domicile Selection SECOND STEP in Development Process of a Captive -

Legal and regulatory jurisdiction in which the Captive will form and operate

Back 2

- offshore/onshore - how much is put up to get license - how much surplus must we maintain - taxes fees licensing costs, geographic convenience, political climate, investment regulations, permitted business lines

Front 3

Application for the Insurance License is THIRD STEP in Development Process of a Captive

Back 3

Select service providers, prepare business plan, meet regulators, submit application - Once regulators indicate willingness to issue license - can move on to Formation

Front 4

Formation and Funding is FOURTH/LAST STEP in Development Process of a Captive

Back 4

get Sr. mgmnt to commit long term, incorporate, adopt bylaws, elect D&Os, open bank acct, deposit capital, actually get license - group captives est membership and financial guidelines, contract w svce providers, reins, front - Issue policies

Front 5

Components of Simple Projected Captive Pro Forma Financial Statements

Back 5

Income Statement - gross prem, ceding comm, net ceded prem, u/w exp & profits, investment inc, taxes, net inc, earned surplus
Balance Sheet - Admitted Assets, Liabilities, Capital

Front 6

Traditional vs. Finite Risk Characteristics
Typical Finite Program: fully funded on TVM, High Sev/Low Freq/hard to predict cov unavail or exp, dampens eff of catastrophic loss on org financial statements

Back 6

Spread of Risk - TI relies on Law of lge numbers which do not apply to F
TVM - Finite funded on investment inc, not TI
TI annual, F multi yr - to fund infreq loss
Ins vs Uninsurable - F ins anything that can be quantified.qualified funds all losses within agg limit

Front 7

Fronting - use of insurance company (domestic admitted carrier) to issue policies on behalf of captive
-Provides services & use of its license for a fee
-Issues a policy to the insured and pays losses
-Generally requires security (LOC)

Back 7

Used by Captive if:
1. states require insurers to provide policy from licensed and admitted carrier (workers comp/auto)
2. third party requires COI from RATED carriers

Front 8

Six types of Captives

1. Single parent - insures the risks of its owner
2. Group captive - multiple, unrelated organizations

Back 8

3. Association captive - trade association members
4. Agency captive - agency clients
5. Rent-a-captive - Licensed Offshore owned by outside org
6. Risk Retention Group

Front 9

Captive Insurance Companies

Back 9

closely held ins company whose business is supplied & controlled by owners, owner/ insureds are the
beneficiaries - subject to insurance regulation - non admitted & non authorized carriers

Front 10

Risk retention group

Back 10

1. group captive whose business is limited to liability coverage for owner-insureds.
2. domiciled & regulated by one state, permitted by federal law to operate in all other states
3. Ex: Products Liability, Professional Liability

Front 11

Reasons to form a captive

1. Availability of coverage
2. Pricing inequity - instability of ins market cycle

Back 11

3. Need for better loss control, claim settlement
4. Lack of flexibility - cove insufficient for needs
5. Inappropriate regulation of rates & forms
6. Lack of Val - TI exp when losses are predictable

Front 12

Advantages of a captive - provides control over claims, reserving practices and investments made
1. Reduction in the long-term cost of risk
2. Reduced operating costs
3. Investment income and operating profit

Back 12

4. Broader coverage
5. Equitable rating
6. Coverage stability and availability
7. Direct reinsurer access
8. Improved services
9. Fewer regulatory restrictions
10. Enhanced risk management perspective

Front 13

Disadvantages of a captive
1. Internal administrative costs
2. Long-term capitalization and commitment
3. Dependence upon service providers

Back 13

4. Inadequate loss reserves and potential losses
5. Complex taxation issues
6. Increased cost or reduced availability of other
insurance

Front 14

Characteristics of a captive
1. Loss sensitivity is high.
2. retention is 100%
3. Premium certainty is high, owners control rates

Back 14

4. Cash flow benefits - invest prem & reserves
5. Service options are flexible
6. Program flexibility is high
7. Accounting/tax impact is complex - requires knowledgeable tax counsel to avoid problems

Front 15

Pooling Arrangements

Back 15

designed to jointly manage the loss exposures of
two or more organizations that are unable to legally or
feasibly self-insure these exposures - State Specific

Front 16

Advantages of Pooling Arrangements
Cost stability,
Cost reduction,
increased focus on loss control and claims management,

Back 16

Coverage forms can be designed to meet members’ needs,
Rating flexible to reflects group’s combined loss experience,

Front 17

Business and Insurance Decisions Affected by Reserves
A. Retention levels
B. Insurance and reinsurance pricing
C. Safety and loss control programs

Back 17

D. Product and services pricing
E. Forecasts of future results for budgeting
F. Tax management
G. Merger and acquisition pricing and terms
H. Financial reporting

Front 18

Uses of finite risk reinsurance contracts

Back 18

Loss Portfolio Transfer
Eliminate potential IBNR time bombs
Addresses gaps in coverage purchased in prior periods

Front 19

Disadvantages of Pooling Arrangements
Joint and several liability all members of a group are jointly liable for group responsibilities and each member is individually responsible for total liabilities of the group.

Back 19

1. Increased U/W risk due to political pressure
2. Risk sharing within a smaller universe
3. Joint and several liability
4. Board members may lack expertize
5. Inadequate records - U/w & Financial data

Front 20

Purposes of actuarial services
-Provide statements of actuarial opinion to regulators for self-ins programs and captive formation
-Evaluate the ult value of losses & IBNR losses; key components of loss sensitive risk financing programs

Back 20

-Assure insured organizations that insurance premiums and retentions are appropriate
-Make loss projections used for forecasting and budgeting
-Complete loss reserve reviews

Front 21

purposes of loss triangulation


1. Reflects growth in losses due to IBNR claims

Back 21

2. Determines loss payment pattern over time
3. Captures changes in ultimate value resulting from natural claim development
4. Reflects changes in losses after initial reserve is
established (new information)

Front 22

Basic types of loss triangulation

Back 22

1. Paid loss (severity)
2. Incurred loss (severity)
3. Claim count (frequency)
4. Claim payout (timing)

Front 23

Audit finding with the risk concern;
1. Self-insurance plan - Outstanding liabilities
2. Captive Exists - Infrequent actuarial review
3. Solvency of ins carrier - Recovery of funds
4. Incr ded - No historical losses, adequacy of cash

Back 23

6. Reduced liab lim -Incr in high-level retained losses
7. Decision not to purchase ins -No historical losses, uncovered losses
8. Cash flow plans - Adequacy of cash, o/s liabilities
9. Unchanged prop val - inflation impact , purchases, sales , capital expenditures

Front 24

Two major accounting standards for risk managers

1. FAS 5 for private and public organizations
2. GAS 10 for governmental entities

Back 24

g

Front 25

Loss Reserve - accounting rules state we need to set up reserve for any expected future payment for any claim which has already occurred prior to the date of the financial statement (ex: 12/31/14)

Back 25

Loss Reserve = Case Reserve plus the IBNR

Front 26

Case Reserve: funds established to pay claims of
which the insurance company has knowledge but has
not yet been settled

Back 26

Individual reserves are established by

a. TPAs
b. Carrier claims adjusters
c. In-house staff

Front 27

IBNR - Incurred but not reported - three parts:
PURE IBNR - truly occurred prior to date but not reported so carrier does not know it exists
Adverse development on known claims 1 out of 5 back injuries will be severe

Back 27

Re-opened Claims - claim closed by end of term, but re-opened due to additional treatment needed

Front 28

Loss and Loss Expense Reserves

Back 28

Allocated - attributed directly to a specific claim

Unallocated - any other exp related to settling the claim - adjuster salaries, ovehead for running claims dept

Front 29

Gross Reserves or Net Reserves

Back 29

affected by salvage, reinsurance
and/or other recoveries

Front 30

Undiscounted and discounted reserve values
either discounted for anticipated investment income or undiscounted - ex: NCCI just closed out last payment from all claims which occurred in 1918

Back 30

most reserves are undiscounted true expected total cost - discount reserve by anticipated investment income - discounted much smaller number

Front 31

Case reserving philosophies

Back 31

a. Stair-stepping (adjuster changes reserve as
additional information comes in - bumps up every yr)
b. Reserve to ult (uses development factors - inflation)
c. Automated - predictive modeling programs /pro forma

Front 32

Total reserve = Total Reported Losses x Development Factors+ Pure IBNR reserves

Back 32

Reserve additions
a. Case reserves are normally inadequate for setting
estimates of ultimate liability to the organization
b. Industry experience shows case reserves are
inadequate and IBNR estimates are required

Front 33

Triangulation is a study of changes, the relationship of one period to a previous period. The process involves graphs in which the data is displayed in an inverted right triangle, hence, the term “triangulation”

Back 33

1. Summary loss data obtained
2. Raw data is displayed in a triangulation format
3. Calculate age-to-age factors (the change from one period to the next for each year)
4. Calculate average age-to-age factors for each valuation interval (12 to 24, 24 to 36, 36 to 48, etc.)
5. Chain multiply the average age-to-age factors to obtain age-to-age ultimate factors
6. If a tail factor is provided by an actuary or other source, include the tail factor in the chain

Front 34

1. Custodial account - Ties up capital/credit line and is not bankruptcy proof
2. Pre-funded deductible plan Ties up cash and additional funds must be deposited with an adverse loss.

Back 34

3.Letter of credit - Cost and availability depends on the insured's credit rating.
4. Opportunity costs Cash or cash equivalents

Front 35

Definitions of risk - “Uncertainty that may be either positive or negative, arising out of a given set of
circumstances.”

Back 35

A. Types of risk
1. Pure – chance of loss or no loss, no chance of gain
2. Speculative – chance of loss or gain,

Front 36

Six General Classes of Risk

1. Economic
2. Legal
3. Political

Back 36

4. Social
5. Physical
6. Juridical

Front 37

Risk Management

Back 37

“The process of managing uncertainty of exposures
that affect an organization’s assets and financial
statements using five steps: identification, analysis,
control, financing administration.”

Front 38

Five Steps of the Risk Management Process

Back 38

Five Steps of the Risk Management Process
1. Risk Identification
2. Risk Analysis
3. Risk Control
4. Risk Financing
5. Risk Administration

Front 39

Learning Objective #3:
Discuss the components of the total cost of risk
Definition: sum of all costs and expenses associated
with the risk management function of an organization

Back 39

TCOR = insurance costs + retained losses + risk
management departmental costs + outside services fees + quantified indirect costs

Front 40

The TCOR is used as a key risk management tool to
1. Assist with making effective risk mgmnt decisions
2. Measure progress toward risk management
objectives
3. Focus and promote safety and loss control

Back 40

4. Provide management and employee incentives
5. Assist with accurate pricing of products and
services
6. Assist with effective management of financial
budgets

Front 41

Basic Tenets of Risk Management
A. Don’t retain more than you can afford to lose.
B. Don’t risk a lot for a little.
C. Consider the likelihood of events and their potential impact.
D. Don’t treat insurance as a subs for risk control.

Back 41

D. Don’t treat insurance as a subs for risk control.
E. There is no such thing as an uninsured loss; an
uninsured loss is a retained loss.
F. Use at least one risk control technique and one risk financing technique for each exposure identified.

Front 42

Retention-transfer diagram – graphic depiction of an
organization’s financial ability and risk appetite

Back 42

1. Budgeted losses = planned retention based on losses the organization is willing/able to retain
2. Tolerance corridor = retention beyond
budgeted amt that the org may also choose to retain
3. Retention = budgeted losses + tolerance corridor

Front 43

Measures of central tendency

Back 43

a. Mean - average;
b. Median – midpoint of the observations ranked in
order of value; (also known as the 50th percentile)
c. Mode – the observation that occurs most often in
the sample; the highest frequency

Front 44

Measures of dispersion

a. Range – the difference between the highest value
and the lowest value of an observation

Back 44

b. Variance – modified average of the squared
deviation of each value from the mean of those
values
c. Standard deviation – square root of the average of
the squares of the variance

Front 45

Trending and loss development
a. Trending – indexing losses and exposures for
inflation

Back 45

b. Development – how losses will ultimately pay out
over time because of the nature of the losses
1) Based on industry statistics
2) Based on specific organizational data; must
have enough loss data

Front 46

Characteristics of Simple Financing Options

Back 46

A. Rely heavily upon insurance policies
B. Amount retained deductible is relatively small.
C. total cost of risk, consists of the premiums, the small amount losses retained, and other exp incurred for services.

Front 47

Reinsurance – a contractual agreement in which one insurer
agrees to insure the assumed liabilities of another insurer, a
self-insured firm, or another reinsurer

Back 47

Types of reinsurance contracts
1. Treaty reinsurance
2. Facultative reinsurance

Front 48

Forms of reinsurance

a. Quota share – the primary insurer or ceding
company cedes (sells) a portion of every exposure
it insures within a class or classes subject to the
treaty. Both premium and losses are shared
according to a stated percentage of the amount of
insurance written.

Back 48

b. Surplus share – the primary insurer or ceding
company cedes to the reinsurer a pro rata share of
risks when the amount of risk exceeds a net
retention described in the treaty.

Front 49

Guaranteed Cost Plan
B. Advantages
1. High premium certainty (subject to audit
of exposures known to insured)
2. all services are provided by the insurer

Back 49

3. Certificates of insurance are provided by insurer or agent/broker
4. Coverage is standardized and predictable
5. Poor experience may go “unpunished” at renewal
(deferred to later renewals)

Front 50

Guaranteed Cost Plan
C. Disadvantages
1. Insurer’s expenses and profits are passed along
2. Limited cash flow due to deferral of premium
3. Good experience may go unrewarded at renewal

Back 50

4. Services may be inappropriate, inadequate
5. Coverage & rating inflexible with few options
6. Long-term total cost of risk may be affected because there are no short-term incentives to reduce losses

Front 51

Dividend Plan -
1. Dividend options are applied to standard guaranteed cost plans, 100% external financing of risk, small ded if any,
Dividends cannot be guaranteed by insurers

Back 51

Dividend factors are conservative and biased
toward insurance carrier - Accounting and tax impact – same as GC plans except dividends are taxable as ordinary income

Front 52

Dividend Plan Advantages:
1. premium certainty
2. a reduction in losses MAY be rewarded
3. Dividends calculated quickly (6 to 18 months)

Back 52

Disadvantages:
1. Dividends not guaranteed
2. no control claims reserving practices of insurer
3. plan loss sensitive to severity, one large claim can eliminate dividend; ins may w excellent risk control will not earn a dividend

Front 53

Small Deductible Plan - Ded option is applied to a standard guaranteed cost plan, Size of “small” is relative; ($25,000), rates based on estimated
exposures and fixed, Insurance carrier provides all services, Degree of loss sensitivity severity/frequency

Back 53

Insurance cost stable, except for cost of collateral required under the deductible reimbursement plan. Retained losses will vary and the total cost of risk will be affected accordingly.

Front 54

Small Deductible Plan Advantages
1. reasonable budget certainty
2. Easy to implement, understand, and relatively easy to administer (depends on insurer)

Back 54

3. Insurance policy and certificates are standard
(deductibles do not need to be shown on COI
4. Direct Savings & cash flow benefits can be substantial, if frequency low & credits reasonable
5. Real incentive to reduce frequency is introduced

Front 55

Disadvantages
1. Often inflexible related to coverage and pricing (class
rated)
2. Credits are frequently inadequate to justify added risk
(depends on circumstances)
3. Services may be inadequate
4. Insured has a heightened incentive to be interested in
the claims handling, but has little or no control over
payments made to claimants or claim settlements
(reserving is not a vested interest)
5. Insured may be required to offer a form of security,
often in the form of escrow, which reduces cash flow
advantages

Back 55

6. Accounts may be open for long periods before final cost is known for those claims with
long development – depends on the plan and insurer