Risk Financing
Retention versus transfer
Every organization retains some risk through deductibles, self-insured retentions, or captives. Transfer mechanisms include commercial insurance, reinsurance, and contractual indemnity. Cost of risk = premiums + retained losses + administrative costs + risk control spending.
Insurance mechanics
- Occurrence policy: covers events occurring during the policy period regardless of when reported.
- Claims-made policy: covers claims reported during the period; a prior-acts endorsement extends coverage backward to a retroactive date; tail coverage (extended reporting period) covers claims reported after the policy ends.
- Excess/umbrella: responds above primary limits; an umbrella may drop down over gaps.
- Captives: single-parent, group, or rent-a-captive; regulated by domicile; require a feasibility study, actuarial funding, and reinsurance.
- Risk retention groups: formed under the federal Liability Risk Retention Act; licensed in one domicile but able to operate nationally, for liability risk only.
Actuarial concepts
Loss runs, development factors, frequency and severity, incurred-but-not-reported (IBNR) reserves, and funding versus reserving. Underwriters price on historical losses, exposure, and risk-control practices.
Traps
Questions assume a captive saves money without accounting for capitalization and regulatory cost, confuse tail coverage with prior-acts endorsement, or assume an occurrence policy only pays claims reported during its term (it does not). Watch for the frequency/severity mismatch.
Rule of thumb
Retain high-frequency, low-severity risk; transfer low-frequency, high-severity risk.