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Aon Risk Finance

New risk financing decisions must be taken continuously against the backdrop of an
undertaking's market environment, risk capacity and current risk situation. We support you in
developing a risk financing strategy tailored to the needs of your company: we make the
necessary tools available to adapt and implement your risk-financing strategy to the changes in
your business and its environment.
Nexus between risk financing and risk management
To develop a financing strategy for entrepreneurial risk, a company must first identify and
analyse the relevant risks. And to determine a suitable risk financing solution, the company's
risk-bearing capacity and financing possibilities on the insurance and capital markets must flow
into the decision-making.

The available risk financing solutions are basically:

 insurance
 own risk-bearing
 self-insurance solutions (captive insurance), and
 other alternative risk transfer solutions
 
Analysis, advanced development & implementation of risk financing strategy
Our consulting covers the full range of risk financing and is geared to the CFO, the head of the
insurance department, the manager of the in-house broker, and the head of risk management.

We analyse your financing options, develop a risk financing strategy, and support you in its
implementation.
We do not regard risk financing merely as a cost element to be optimised. On the contrary, we
believe the strategy should also generate value for your core business. Accordingly, we closely
examine your business model and propose company-specific solutions which dovetail with your
company's value drivers.

Our consulting approach, based on collaborative work with our clients, comprises both
conceptual and operational support in the development, advanced development and
implementation of existing strategies, processes, organisation, key data and documentation.

Typical consulting projects:

 checking risk-bearing capacity

 defining risk financing strategies
 reviewing insurance programme structure
 analysing compliance of international insurance programmes
 developing appropriate key indicators for insurance management
 developing insurance management concepts
 integrating insurance management concepts into the risk management system
 quantitative and qualitative analysis of alternative risk financing strategies
 
Alternative risk financing strategies and captive solutions
As part of the risk financing strategy, we offer specific consultancy solutions in the field of
alternative risk transfer. This includes securitisation of insurance risks when conventional
insurance capacities are insufficient, as well as consulting on captive-specific issues:

 captive feasibility check and consulting

 implementation of primary and reinsurance captives
 review and development of insurance captives and captive strategies
 development of appropriate structural and procedural organisation for captives taking
into account regulatory requirements, e.g. under Solvency II
 settlement and resettlement of insurance captives
Our consulting team consists of actuaries with many years of extensive experience. Would you
like to learn more about the services of our Risk Finance Team? Contact your client advisor.

Contact

Lukas Niedermann
Phone: +41 58 266 86 11
Email: lukas.niedermann@  
aon.com

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Alternative Risk Financing / Transfer /
Captives
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 RISK FINANCING / TRANSFER OPTIONS

 INSURANCE LAYERS
 DECISION CRITERIA

 SOURCES OF ARF / CAPTIVE INSURANCE FACILITIES

 RECIPROCALS / RISK RETENTION
 OTHER RESOURCES

Risk Financing / Transfer Options

The following are some of the alternatives to traditional guaranteed cost insurance:

 Fund from Cash-Flow (Self Insure / Large Deductible or Self Insured Retention / Internal Fund / Sinking Fund /
Lending Agreement)
 Retrospective Rating Program
 Finite Risk / Financial Reinsurance / Chronological Loss Stabilization Program / Multi-Line Integrated Program /
Multi Year / Multi Trigger / Blended Risk Contracts (Operational Risk Only) / Blended Risk Contracts
(Operational & Financial Risks)
 Wholly Owned Captive / Rent-a-Captive / Protected Cell Company / Association Captive / Agent Owned Captive
 Risk Retention Group / Purchasing Group / Pooling Arrangements
 Reciprocal Insurance Exchange (Canada – except Quebec)

 Industry Focused Insurance Companies

 Insurance Linked Securities (Catastrophe Bond / Securitization) / Non-Catastrophic Securitization / Future Flow
Transactions / Financial Guarantee / Loan Guarantee / Derivatives / Futures / Options / Swaps
 Insuritization – Using an insurance contract to hedge against financial risks (e.g. currency/portfolio risks)
 Loss Portfolio Transfer

Many large organizations will structure their risk financing program to incorporate two or more of these options,
and usually the optional choice will be different for each layer of coverage.
The merits of each option should be evaluated individually, however, it is important to reach an overall conclusion
that considers the most effective combination of alternative options.

Insurance Layers
With risk financing it is common to consider an organization’s risk and / or insurance arrangements in terms of
various layers of cover. These layers are generally defined as follows:

 Primary Layer  – This layer contains the high frequency / low severity losses which are essentially predictable. It
is unlikely that any single loss in this layer could seriously impact a large organization although an
accumulation of claims in any one financial period may create a problem. This layer generally falls within local
deductibles with claims paid by Operating Companies.
 Working Layer  – This layer contains the medium frequency / medium severity losses where there are only a few
losses a year expected. An individual loss may seriously distort the budget / financial performance of any
operating unit although it is not likely to present a major problem for the Group as a whole. The decision to
insure or self-insure this layer of risk depends upon the appetite for risk-taking that the management of the
organization has and sometimes is influenced by the terms offered by insurers.
  Catastrophe Layer  – This layer contains the low frequency / high severity losses. An individual loss of this
magnitude can seriously distort the financial results of the organization in any one financial year and, may
even threaten the whole organization. It is essential that insurance or an alternative method of risk transfer is
used to deal with these risks.

Depending on the size of the organization, the definition of these layers will vary based on its financial strength
and the historical claims experience. The next step is to evaluate the most effective risk financing option for each
one.

Decision Criteria
The following decision criteria have been identified as common standards for evaluating risk financing
alternatives:
Ensure Continuity of Operations
For most companies the objective of insurance / risk transfer is to ensure continuity of operations following a
catastrophic loss. This may often be referred to as providing ‘peace of mind’.
Ensure Preservation of Assets
Key assets should be protected by insurance or other methods of risk transfer to ensure restoration / rebuild in
the event of a loss.
Minimize Long-Term Costs
The objective of an insurance program and the selection and position of appropriate risk financing vehicles is to
minimize cost over the long-term. Except in very soft market conditions it is not usually cost-effective for a large
organization to buy full ground-up insurance because the smaller, predictable claims can be self-insured more
efficiently.
Smooth Profits or Losses Over Time
From a financial budgeting point of view, it is much easier to work with costs that do not vary wildly from one year
to another, as can often be the case when relying on traditional insurance markets.
Availability of Capital
The organization may already be committed to a significant capital investment program. This may influence
decision-makers against options that involve short-term and significant capital outlay e.g. a captive insurance
company.
Plan for the future
Most large commercial organizations restructure operations on a regular basis. It is important that any risk
financing strategy including the selection of a vehicle, should be flexible enough to respond to the future structure
of the company.
Control Over The Program

The risk financing vehicle selected must allow the organization to maintain and develop control over risk
exposures. When assuming responsibility for the cost of retained losses and uninsured losses it will naturally
require the promotion of risk management, better communication, motivation and awareness. The risk financing
method selected should enhance the level of these various aspects of the organization thereby aiding in control.
Be Practical and Achievable Within a Reasonable Timeframe
The risk financing vehicle selected should be practical and there should be reasonable expectation on
implementation to an agreed, acceptable timeframe e.g. within a year.
Weighting of Criteria
An insurance / risk retention program for a large organization normally involves a mixture of risk financing
alternatives. In finding the optimal risk financing option, it is necessary to take into account that some of the
criteria identified above are more important than others. The weightings applied to each of the criteria are
therefore selected and refined following discussions with management of the organization.
For the working and catastrophe layers a much higher weight is usually assigned to the availability of capital. For
the primary and working layers the first three criteria (i.e. continuity of operations / preservation of assets /
minimize long-term costs) have been allocated zero weight because they have little relevance.

Sources of ARF / Captive Insurance Facilities

 ARI Risk Management Consultants

 Arch Capital Group Ltd.
 ARTEMIS – Alternative risk transfer site.
 Andrew Barile Consulting Corporation
 CCMSI
 Chubb
 Chubb Atlantic Indemnity Ltd
 Dion Durrell

 FM Global – Captives and Alternative Risk

 IMG International
 Insurance Futures Exchange Services Ltd. (IFEX)
 Liberty Mutual Captives
 The Claymore Group
 The Taft Companies
 Travelers
 Willis Captives
 XL Group

Reciprocals / Risk Retention

 Canadian Petroleum Insurance Exchange

 Canadian Universities Reciprocal Insurance Exchange
 Community Newspapers Reciprocal Insurance Exchange
 Dion Durrell
 Governmental Interinsurance Exchange
 MEARIE – Municipal Electric Association Reciprocal Insurance Exchange.
 Municipal Insurance Association of B.C.

 National Risk Retention Association

 Ontario Municipal Insurance Exchange
 OSBIE – 106 members, representing over 95% of the school boards in Ontario.
 Risk Retention Reporter
 The National Catholic Risk Retention Group, Inc.
 United Educators Insurance – U.S. school risk retention group.

Other Resources

 Appleby
 Barbados Exempt Insurance Companies
 Bermuda Insurance Market
  Bermuda Laws On-Line
 Bermuda Stock Exchange
 Canadian Captive Insurance Association
 CAPTIVE.COM
 Captive Insurance Companies Association (CICA)
 Captive Insurance Company Domiciles – From IRMI
 Captive Insurance Council of the District of Columbia
 Conyers Dill & Pearman – Bermuda law firm.
 Dublin International Insurance & Management Association

 Financial Action Task Force on Money Laundering

 Guernsey Financial Services Commission
 Incisive Media Plc
 Insurance Taxation and Regulation Publications
 International Compliance Association
 Internal Revenue Service
 KPMG Bermuda
 Offshore Alert
 Ruchelman Law Firm – International Tax Lawyers
 Self-Insurance Institute of America, Inc.
 The Bermuda Foundation for Insurance Studies
 Vermont Captive Insurance Association
 WWWoods & Co

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What is alternative risk financing?

Most medium-sized and smaller

companies protect themselves against their property and liability exposures by
purchasing Commercial insurance, while large corporations and government
agencies prefer to use some type of alternative risk financing. However, businesses
of any size can employ this tool to enjoy such benefits as improved cash flow and a
lower total cost of risk.
Insurers have developed a number of colorful terms for alternative risk financing
techniques. These methods include:

 Excess insurance
 Reinsurance
 Guaranteed cost
  Retrospective rating
 Large deductible
 Self-insurance
 Captive insurance
Using alternative risk financing requires management discipline and a willingness
to commit resources. Size isn’t that important. The main criterion is losses. As a
rule of thumb, alternative risk financing makes sense for a business whose claims
have these characteristics: (1) Reasonable predictability; (2) moderate volatility;
(3) minimal exposure to a catastrophic event; and (4) high frequency and low
severity. For example, a large hotel or bank would probably experience a number
of small Workers Compensation claims, but few large claims.
Casualty insurance products (such as Workers Comp, General Liability, and Auto
Liability) are the best candidates for alternative risk financing. Because Comp and
Liability claims tend to be paid over one to five years or more, insurance
companies that write these policies generate substantial investment income on their
premium reserves until losses are paid fully. By using alternative risk financing,
your company can invest your funds elsewhere, rather than paying premiums.

Our specialists would be happy to review your business and see if alternative risk

financing make sense for you.

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PERSONAL FINANCE    INSURANCE

Alternative Risk Financing Facilities

By 
LUCAS DOWNEY
 

Updated December 03, 2020

Fact checked by 

DANIEL RATHBURN
Insurance

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What Are Alternative Risk Financing Facilities?

An alternative risk financing facility is a type of private insurance created and funded
by its customers to provide coverage tailored to their needs. They were originally
formed by groups of people or organizations with a common need for a type of
coverage that was not available commercially, but the concept is now being adopted
more widely.

KEY TAKEAWAYS

 Alternative risk financing facilities are private insurers that offer coverage for
a closed group of customers with similar needs.
 Alternative risk financing facilities may be used to insure against a broad
range of risks including medical malpractice, workers' compensation, and
officers' liability.
 Such facilities are increasingly being adopted instead of conventional
commercial insurance policies.

Understanding Alternative Risk Financing Facilities

Alternative risk financing facilities are increasingly being adopted as a way to control
insurance costs and obtain coverage that is customized for the requirements of a
specialized business. They may be used to supply property-casualty insurance,
worker's compensation, directors and officers liability insurance, and
medical malpractice insurance.

The type of businesses that might create such facilities include banks, medical
professionals, manufacturers, and public entities. This consortium of businesses
becomes a closed pool of clients for insurance purposes.

In most cases, the insured parties supply the initial start-up capital to fund the
facilities.

The Market for Alternative Insurance

According to actuarial consultant Perr & Knight, the number of businesses adopting

this type of insurance has skyrocketed in recent years to more than 50% of
the commercial insurance market.

Here are some of the reasons this type of insurance is growing, according to Perr &
Knight:

 It eliminates reliance on commercial insurance, allowing a business to

reclaim control over its risk financing.
 It lowers insurance acquisition expenses.
 It can stabilize insurance pricing over time.
 It can provide coverage that is unavailable or unaffordable elsewhere.
 It allows access to reinsurance markets.
 It provides cash flow benefits.
 It allows for greater customization of insurance.
 It improves claims handling and control. 1

About Commercial Insurance

Conventional commercial insurance provides a wide risk pool. The premiums paid
by businesses or individuals with low risks and those with high risks are pooled
together to allow for reimbursement of claims by any and all participants. By its
nature, commercial insurance uses the resources of its best customers to repay its
worst customers.

As a closed group, the risk financing facility focuses on the specific risks associated
with a specialized business segment or group.

Other Options

The risk financing facility is one choice for businesses among several in the growing
field called alternative risk financing.
The best known is self-insurance, which requires a business to establish a fund to
draw upon as needed to meet losses. Another is the captive insurer, an insurance
company that is wholly owned by the business or businesses that it covers.

The alternatives are about cutting out the middleman in the insurance transaction.
Generally, they are best adapted to large businesses or to a consortium of small
businesses with similar interests since they may require a greater up-front
investment.