Active Retention deliberate decision to engage in rentention
Passive Retention retain the loss exposures but you area unaware of doing so, usually a failure to
properly identify the loss exposure
Complete Retention assume full cost of losses
Partial Retention assume part of the losses and transfer the rest
Funded Retention a pre-loss arrangement, a firm or individual sets aside a fund to pay for losses
when they occur
-this is the best option for losses that are predictable and has higher severity
Unfunded Retention no fund is set aside before the losses. when a loss actually occurs, use current
revenue or cash flow to pay for the losses
-this is best for losses that are more predictable and have a lower severity
*if you don't have enough to pay for the losses you might have to borrow money
Self-Insurance insure yourself- its a pre-planned assumption of financial responsibility of losses
-not buying market insurance
-a formal, internal allocation of capital to pay for losses
-amount of $ set aside are determined by actuarial estimation of (f) and (s)
-$ may be put in a trust, may be administered by a 3rd party
-the entity self-insuring will collect premiums; establish a loss reserved to pay for
future losses
2 Necessary Requirements for Self-Insurance 1. Must have a group of loss exposure unites that are large enough to accurately
predict expected loss
2. Prefunding of expested loss through a fund set aside and designed specifically
for that purpose
6 Advantages of self-insurance 1. Control over claims (statements of loss)
2. Risk Control - mitigates moral hazard
3. Reap benefits of a successful risk control
4. Save $: saving Risk Charge
5. Gain investment income
6. Flexibility in terms of benefit design
-self-insurance is exempt from most state mandates
1 Disadvantage of self-insurance Possibility of catastrophic loss that self-insurance cannot pay for. Maybe because
it's less predictable. You can do self-insurance and buy "stop loss insurance"
(market insurance)
2 Disadvantage of self-insurance Self-ins firms have to perform administrative work, which could be expensive.
Could hire EE or hire third party administrator (TPA/administrative service only
(ASO))
3 Disadvantage of self-insurance Public relation problem: TPA of ASO helps to mitigate this problem
4 Disadvantage of self-insurance May be hard to return to market insurance once you leave to self-insurance
Signal >> might be bad risk >> no insurance company wants to insure you
, 5 Disadvantage of self-insurance tax code favors market insurance against self-insurance
ex. workers comp insurance
6 Disadvantage of self-insurance Contractual requirements: some contracts do not allow self-insurance
Captive Insurance is a subsidiary formed by the parent company the main purpose of a captive is to
provide insurance for parent
-parent sets up the captive
-parent pays premium to the captive
-parent takes tax deduction for the premium
-captive receives premium, records it as revenue, increases loss reserve by an
amount = premium
so captive shows little or no profit and pays little tax
Best places for captives: Domestic = Vermont : Foreign/Offshore = Cayman
Islands
5 Advantages of Captive Insurance 1. Tax advantages
2. Customized policies
3. Less restraint on investments than self-i
4. You direct access to reinsurance market
5. In a hard (premium very high, coverage very, very difficult to get coverage)
market, the parents have affordable insurance coverage
2 Disadvantages of Captive Insurance 1. Expensive
2. Involves lots of labor; finance, actuaries accounting,legal
Loss Matrix indicates for each possible RM option and state of world, the expenditure
associated with that combination
5 RM Options 1. Avoidance
2. Loss prevention
3. Loss reduction
4. Retention
5. Insurance
State of World loss or no loss; partial loss
Focus on pure risk
After-tax cost =pre-tax cost* (1-Tax rate)
Decision Rule choose the option that minimizes the expected cost
Actuarial Fair Premium price is exactly enough to cover your expected cost and numerically equals the
expected cost of retention
PMAX PMAX=EC+WV
the max premium you are willing to spend for full insurance against a loss
Passive Retention retain the loss exposures but you area unaware of doing so, usually a failure to
properly identify the loss exposure
Complete Retention assume full cost of losses
Partial Retention assume part of the losses and transfer the rest
Funded Retention a pre-loss arrangement, a firm or individual sets aside a fund to pay for losses
when they occur
-this is the best option for losses that are predictable and has higher severity
Unfunded Retention no fund is set aside before the losses. when a loss actually occurs, use current
revenue or cash flow to pay for the losses
-this is best for losses that are more predictable and have a lower severity
*if you don't have enough to pay for the losses you might have to borrow money
Self-Insurance insure yourself- its a pre-planned assumption of financial responsibility of losses
-not buying market insurance
-a formal, internal allocation of capital to pay for losses
-amount of $ set aside are determined by actuarial estimation of (f) and (s)
-$ may be put in a trust, may be administered by a 3rd party
-the entity self-insuring will collect premiums; establish a loss reserved to pay for
future losses
2 Necessary Requirements for Self-Insurance 1. Must have a group of loss exposure unites that are large enough to accurately
predict expected loss
2. Prefunding of expested loss through a fund set aside and designed specifically
for that purpose
6 Advantages of self-insurance 1. Control over claims (statements of loss)
2. Risk Control - mitigates moral hazard
3. Reap benefits of a successful risk control
4. Save $: saving Risk Charge
5. Gain investment income
6. Flexibility in terms of benefit design
-self-insurance is exempt from most state mandates
1 Disadvantage of self-insurance Possibility of catastrophic loss that self-insurance cannot pay for. Maybe because
it's less predictable. You can do self-insurance and buy "stop loss insurance"
(market insurance)
2 Disadvantage of self-insurance Self-ins firms have to perform administrative work, which could be expensive.
Could hire EE or hire third party administrator (TPA/administrative service only
(ASO))
3 Disadvantage of self-insurance Public relation problem: TPA of ASO helps to mitigate this problem
4 Disadvantage of self-insurance May be hard to return to market insurance once you leave to self-insurance
Signal >> might be bad risk >> no insurance company wants to insure you
, 5 Disadvantage of self-insurance tax code favors market insurance against self-insurance
ex. workers comp insurance
6 Disadvantage of self-insurance Contractual requirements: some contracts do not allow self-insurance
Captive Insurance is a subsidiary formed by the parent company the main purpose of a captive is to
provide insurance for parent
-parent sets up the captive
-parent pays premium to the captive
-parent takes tax deduction for the premium
-captive receives premium, records it as revenue, increases loss reserve by an
amount = premium
so captive shows little or no profit and pays little tax
Best places for captives: Domestic = Vermont : Foreign/Offshore = Cayman
Islands
5 Advantages of Captive Insurance 1. Tax advantages
2. Customized policies
3. Less restraint on investments than self-i
4. You direct access to reinsurance market
5. In a hard (premium very high, coverage very, very difficult to get coverage)
market, the parents have affordable insurance coverage
2 Disadvantages of Captive Insurance 1. Expensive
2. Involves lots of labor; finance, actuaries accounting,legal
Loss Matrix indicates for each possible RM option and state of world, the expenditure
associated with that combination
5 RM Options 1. Avoidance
2. Loss prevention
3. Loss reduction
4. Retention
5. Insurance
State of World loss or no loss; partial loss
Focus on pure risk
After-tax cost =pre-tax cost* (1-Tax rate)
Decision Rule choose the option that minimizes the expected cost
Actuarial Fair Premium price is exactly enough to cover your expected cost and numerically equals the
expected cost of retention
PMAX PMAX=EC+WV
the max premium you are willing to spend for full insurance against a loss
