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Alternative Risk Financing: Strategically Financing Risk

posted by TrueNorth Transportation on Thursday, June 20, 2024

​What is Alternative Risk Financing

Protection gaps, a lack of flexibility and the ability to customize coverage are just a few reasons that lead some companies to look beyond traditional insurance. Alternative risk financing is an approach used to finance risk that can include methods and mechanisms such as captive insurance companies, qualified self-insurance, risk retention groups, catastrophe bonds, and more. These techniques may offer more customization, control and potential cost savings.

At our Risk Summit in May, TrueNorth colleagues Dan Cook and Jonathan Stark led a breakout session where they explored alternative risk financing, how to effectively approach strategically financing risk, and the use of captives.

Understanding the 5C’s of Risk Financing™

When determining the risk finance approach that is best for your company, you need to define short, intermediate and long-term considerations. The 5C’s approach can guide you through this process.

• Control: Evaluation of your team’s ability and systems to control enterprise risk and manage claims effectively.
• Cost: Assess the current percentage of your operating cost dedicated to risk financing and potential savings from a total cost of risk perspective.
• Cash Flow: Consider the impact of short-term cash flow on your ability to capitalize on cost advantages.
• Captial: Analyze if a capital contribution for risk financing is feasible and compare it to reinvesting in business growth.
• Collateral: Reflect on the use of collateral for risk financing versus growth, and collateral’s impact and restriction upon your working capital position.

Exploring Captives

A captive is a closely held insurance company owned mainly by its insureds and is a separate legal entity from the company/companies that formed it. It is important to note that captives are a partial risk financing mechanism and are not a full replacement for commercial insurance.

Companies use captives for a variety of reasons, but most often, to improve the cost and/or control over their overall corporate risk. They work best with primary working layers of coverage where the claim activity is predictable and voluminous.

Forms of Captives

• Single Parent Captive: This is the simplest, and most common captive arrangement. The captive is a separate legal entity that insures the risks of its parent or affiliated entities. The parent maintains control over underwriting, reinsurance and investment policy decisions.
• Group Captive: A number of companies come together to form a group captive to collectively insure a portion of their business. This can be broken out by area of focus – casualty captive; medical stop loss captive; property captive.

Keeping Captives Simple

It's best to remember that captives are just a type of insurance company or risk pool that companies utilize for risk financing. They are designed for frequency, not for severity risk. When considering if a captive is right for your business, utilize the 5 C’s approach, evaluate your business’ claim frequency and severity, and rely on the experts for guidance.

Captives in Trucking

For a look at captives in the trucking industry, check out our TTT Podcast Episode, “Evaluation your Insurance Options in Trucking: Are Captives a Good Fit?”

If you’d like more information on the Risk Summit session covering this topic, please fill out the form below: