Risk Financing and Insurance
Financing and insurance
Risk financing answers how the organization pays for retained losses and protects capital. Candidates should know retention, transfer, insurance, captives, deductibles, self-insured retentions, limits, sublimits, coinsurance, exclusions, and claims-made versus occurrence coverage. Insurable interest, indemnity, utmost good faith, and proximate cause are core principles. Total cost of risk includes premiums, retained losses, administrative costs, control costs, and the cost of capital; the cheapest premium is not necessarily the lowest total cost. Retention should reflect capacity and volatility: retain predictable, frequent, low-severity losses; transfer low-frequency, high-severity tails.
Traps: treating insurance as a substitute for controls, confusing a deductible with a self-insured retention, and missing that claims-made coverage responds to claims reported during the policy period while occurrence coverage responds to injury or damage during the period. Watch for limit erosion by defense costs, exclusions that swallow coverage, and aggregate limits shared across claims. Also watch for uninsurable risks such as reputational damage or regulatory fines, and for captive capital and governance requirements.
Worked example: a firm has $4 million of expected retained losses and a worst-case single loss of $30 million. It can absorb $5 million comfortably. A sensible structure retains the first $1 million per claim with a $5 million aggregate, buys a $25 million excess layer, and uses a captive only if it has the capital, governance, and loss data to support it. The decision is based on total cost of risk and capital relief, not premium alone.
Rule of thumb: retain what is predictable and affordable; transfer the volatile tail.