Page 50 - EBOOK RISK MANAGEMENT

5.1.2 Risk Financing

Risk financing is a techniques of arranging funds to cover losses experienced by a

firm. There are two major approaches in risk financing which is risk retention and risk

transfer.

a) Risk Retention

Risk retention means that an individuals or organizations retain some or all of the
loss incurred because there is no other way of dealing with the risks. The individual

or company will bear the consequences of the losses. Choosing risk retention as
companies risk management techniques will benefited the organizations since its

less expensive than purchasing insurance until such time as it is needed to pay

losses.
i) Self-Insurance

Self-insurance or internal sourced of funds is whereby an individual or business

choose to set aside the needed level of reserve funds to cover its risk. If a
business decides to self-insure its risks, there should be typically studies

performed. The fund may come from business income or personal saving to cover
the acceptable losses. This method is recommended when there is no other risk

management technique available, and the losses can be predicted accurately.

i) Captive Insurers

Captive insurance is a licensed insurance company establish by a non-
insurance company (parent) to insure the risk of parent company. Captives

insurers have several advantages over traditional insurance coverage.

Advantages Disadvantages

Reduce insurance cost The parent must contribute the
Able to provide non-insurable capital required to support the
risks which are not offered by captive insurance
commercial insurance Risk of unprofitable underwriting
Reduced the need for commercial increase if the risks are not
insurance correctly evaluated
More flexible to design the The parent may incur high
insurance programme operating cost
Protected cash flow The parent must committed and
Source of additional revenue spend time to manage captive
insurance

Figure 5.4 Advantages and Disadvantage of Captive Insurance

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