Risk Financing - Does size really matter?

All companies big or small are facing an increasing assortment of risks due to changes, in the legal environment, to the climate, to technology and expansion by business into new territories. These risks require constant management and once the relevant r

According to Palesa Mafoko, executive head: risk financing solutions at Centriq Insurance, most medium sized to smaller companies buy commercial insurance policies, whether it be in the form of multi-peril or all risk policies, without giving substantial thought to the use of risk financing tools as a method of financing.

“Risk financing solutions are utilised to satisfy a myriad of insurance and risk issues in companies, including risks that are uninsurable or difficult to insure in the traditional insurance market; and how companies decide to manage and finance these risks can have a significant, direct and long term impact on their financial growth and stability,” Mafoko explains.

Insurers who offer risk financing solutions are in the business of assisting companies, irrespective of size, to manage their risks.

Risk financing involves a combination of traditional insurance (transferring the risk) and retention of some risk in a single insurance policy or a retention programme which is independent of any reinsurance.

The insurance cover provided by these policies can be standard covers (e.g. fire, business interruption, public liability etc.) that are provided by the traditional insurance market as well as customised covers (e.g. strikes no damage, mechanical breakdown, uninsured risks etc.) that are designed to meet the specific needs of each company.

“Medium sized companies have to make the same decisions as the large corporates when it comes to risk financing, namely which risks to retain or transfer,” notes Mafoko, adding that this decision depends entirely on the company and its overall attitude towards risk management.

“The only thing constant is change - and with constant changes taking place in the business environment and insurance markets, companies need to constantly assess their risks and the mitigation thereof. This also means that company decisions regarding retention or transfer of risk need to be addressed regularly,” she says.

Benefits

Mafoko notes that the transfer of certain risks can provide a company with the necessary cash flow when they need it most, thus reducing the risk of bankruptcy and financial distress costs, while the retention of risk:

o encourages better risk management given the fact that the company can participate in the underwriting profits from a good loss history and larger retentions to facilitate reduced cost of traditional insurance,

o allows underwriting profits from good years to be used to subsidise losses that may occur in future years,

o enhances financial and cash flow stability by insulating the company from the effect of price and capacity fluctuations in the traditional market.

Overall, she says there is no rule regarding the ideal sized company for risk financing solutions.

“Companies that should consider risk financing are those who have an appetite for retaining risk, have the financial capacity to do so, are committed to excellent risk management and are interested in the benefits of participating in their own insurance risks. The effect of good risk financing solutions for any company should be a reduction in the ultimate cost of risk,” notes Mafoko.

As such, risk financing or alternative risk transfer (ART) solutions are not strictly the domain of major corporations; they can be utilised by any company that is interested in financing their risks as part of a holistic risk management strategy.