Risk Financing and Insurance
Core idea
Risk financing answers how the organisation pays for residual risk. Candidates should understand the spectrum from retention (absorbing losses internally) through captive insurance and deductibles to full commercial transfer. Key concepts include expected loss, loss volatility, risk retention capacity, and the total cost of risk: premiums plus retained losses plus administration plus the cost of controls.
Insurance mechanics
Know the parties (insured, insurer, broker, underwriter), the principle of indemnity, insurable interest, utmost good faith and the duty of disclosure. Understand sum insured versus limit of indemnity, deductibles and excesses, co-insurance, average clauses, exclusions, warranties and conditions, subrogation, and claims notification obligations. Distinguish first-party cover (own property, business interruption) from third-party liability. Recognise that business interruption cover depends on accurate declared values and indemnity periods.
Traps
Common errors: assuming all policies are 'new for old' or unlimited; ignoring under-insurance and the average clause that reduces payouts proportionally; treating a warranty as a minor formality when breach can void a claim; and forgetting that deliberate or grossly negligent acts are usually excluded. Candidates also confuse an excess with a franchise, and a broker's role with an underwriter's.
Worked rule of thumb
If a property worth 1,000,000 is insured for 600,000 under a policy with an 80% average condition, a 100,000 loss is settled at 100,000 x 600,000/800,000 = 75,000, less any deductible. Check declared values annually; under-insurance silently converts retained risk into a funding gap.