6 - Risk financing, retention and transfer

Question 1

What does the Insurance Act 2015 SPECIFICALLY require a commercial customer to do?

Answer 1

Make a fair presentation of the risk to the insurer.

Question 2

A pharmaceuticals company has decided to set up a company to provide a self-insurance programme for their products liability insurance. This is an example of:

Answer 2

a captive insurer.

Question 3

To minimise the risk of a major fire, contingency plans have been put in place which include identifying other firms to sub-contract work to on a temporary basis. What method of containing costs is being used?

Answer 3

Business continuity management.

Question 4

Which of the services offered by brokers to their clients is typically provided in-house?

Answer 4

Carrying out property surveys.

Question 5

A global retailer is concerned about the potential risk of hurricane damage. It has arranged a contract that will pay a predetermined amount if a category 3 or above hurricane occurs within a specified geographical area within a defined period. What type of risk transfer mechanism is it using?

Answer 5

An insurance derivative.

Question 6

What is an advantage of a self-insurance programme compared to a conventional programme?

Answer 6

Cash flow saving.

Question 7

When an insurer calculates the reserves it needs to meet future unspecified payment liabilities, these will be determined by the company’s:

Answer 7

actuaries

Question 8

Which regulatory body is responsible for minimising the risk of a large UK insurer being unable to meet its financial commitments?

Answer 8

The PRA.

Question 9

When evaluating risks and their potential impact and costs, what is the first step a business should take in developing a risk financing plan for these losses?

Answer 9

Quantify the level of costs that can be absorbed without a significant impact on the company.

Question 10

What type of risk is a national retailer LEAST likely to be able to obtain insurance protection against?

Answer 10

Damage to its brand due to adverse publicity.

Question 11

When an organisation has fully evaluated the risks it faces and considered their potential impact and cost, it needs to develop a risk financing plan. What initial steps should it take?

Answer 11

Initial steps are:
• quantify the level of all costs that can be absorbed without a significant impact on the organisation itself;
• identify potential sources of funding to meet larger losses; and
• consider how such funds can be available at the time they are needed.

Question 12

What are the names of the two regulatory bodies that were established following the enactment of the Financial Services Act 2012?

Answer 12

The Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA).

Question 13

The total cost of a proposed insurance arrangement is the sum of all losses under the deductible level plus the insurance premium quoted. Why is it important to analyze different quotations for different levels of deductible?

Answer 13

As the additional premium may not be worth paying if the organisation is being asked more to cover the losses th.an they are actually expected to cost.

Question 14

Can we add up individual loss estimates to estimate total potential losses?

Answer 14

No, because in estimating total potential losses it is not enough to add up individual losses and their frequency. Aggregate losses must also be considered.

Question 15

Before deciding how to finance risk we need to know how much loss an organisation can afford to absorb without significant impact on its own operations. What two calculations should we make?

Answer 15

The two calculations we need to make are:
• the single largest amount the organisation can afford to retain; and
• the aggregate of losses the organisation can afford to retain over a given time, ignoring low level, common, frequent losses.

Question 16

Why is regulation of the insurance market important for organisations?

Answer 16

If organisations are going to pay premiums now and rely on the insurance market for financing risks that materialize in the future, then they need to be sure the market is stable. It is also important that insurance firms are able to meet their liabilities when organisations need to make a claim.

Question 17

List five additional services brokers can offer in supporting risk management.

Answer 17

• property surveys;
• business continuity plans;
• business interruption reviews;
• health and safety workplace reviews;
• liability surveys;
• motor fleet risk management;
• environmental risk surveys;
• post-loss control services; and
• disaster recovery services.

Question 18

What options are available if one insurer cannot provide cover up to the limits an organisation may need?

Answer 18

• co-insurance, where two or more insurers share the risk;
• excess layers;
• separate umbrella policies; and
• additional policies for specialist cover.

Question 19

What is the usual main reason for large international organisations to consider global insurance arrangements?

Answer 19

The main driver tends to be the desire for effective corporate management and control across the organisation.

Question 20

A captive insurer allows losses to be funded from three different sources according to level of loss. What are the three sources?

Answer 20

The three sources of funding are:
• the cash flow and asset sources of the organisation itself;
• funds available from within the captive; and
• the captive’s reinsurers.

Question 21

State the five conditions for successful risk transfer contracts.

Answer 21

• contract terms are enforceable;
• contract terms are unambiguous;
• the person you have transferred to can manage the risk;
• the person you have transferred to can finiance the risk; and
• the price paid for the risk transfer is reasonable.

Question 22

To estimate total potential cost of risk we must consider …

Answer 22

timing, administration and opportunity costs as well as monetary issues.

Question 23

Monetary issues include …

Answer 23

replacing any assets that have been lost, litigation costs and any regulatory fines.

Question 24

Large, unexpected outgoings can damage cash flows that are needed to …

Answer 24

keep an organisation functioning.

Question 25

Delays in completing rebuilding work or replacing assets are an important factor in the total cost of damage. The longer it takes to re-establish normal working, the longer …

Answer 25

receipts will be delayed, with consequent increases in borrowings and interest payments.

Question 26

Administration diverts management time away from ….

Answer 26

ongoing needs of the business and generates additional work.

Question 27

An organisation choosing to retain risks internally may need to create an infrastructure that can handle what may be a large …

Answer 27

number of individual incidents and their aftermath.

Question 28

Loss events may detract from an organization’s ability to achieve its business and financial plans. This is known as an …

Answer 28

opportunity cost as the organisation is unable to pursue opportunities which would have generated profits.

Question 29

There is a range of statutory agencies that have the power to impose an investigation on an organisation. In the UK these include …

Answer 29

the Environment Agency, Health and Safety Commission and HMRC.

Question 30

Individual loss assessment is not sufficient. What must also be considred?

Answer 30

Aggregate losses

Question 31

Organisations have to recognise that some events cannot be either totally avoided or insured, so they need to plan what they are going to do if a major incident occurs. This process is known as

Answer 31

business continuity management.

Question 32

The aim of business continuity management is

Answer 32

to keep a system operational despite losses occurring and to restore it as quickly as possible to its original state. Plans and procedures are put in place to limit the extent of damage, financial or otherwise, a significant event may cause.

Question 33

It is important that an organisation recognizes all sources of indirect costs and understands clearly the full …

Answer 33

extent of losses that may be faced.

Question 34

In order to decide how important individual losses are we need to know how much loss an organisation can afford to absorb without …

Answer 34

significant impact on its own operations.

Question 35

Risk impact limits will involve calculating:

Answer 35

• the single largest amount the organisation can afford to retain; and
• the aggregate of losses the organisation can afford to retain over a given time, ignoring low level, common, frequent losses.

Question 36

A modern organisation, however large and strong, still needs to protect large amounts of assets from …

Answer 36

simultaneous, sudden loss, and also to stabilize its revenues and profits over time.

Question 37

Cost-effective insurance is not always readily obtainable. Many insurers like to sell standard insurance packages with covers and premiums they feel able to …

Answer 37

Profit from

Question 38

CIDRA covers insurance contracts with individual consumers, while the Insurance Act 2015 deals with …

Answer 38

commercial contracts for businesses. They clarify the rights and obligations of both insurer and insured, spelling out disclosure obligations and what happens if the information is wrong or relevant circumstances change.

Question 39

Insurance companies and intermediaries in the UK are regulated by …

Answer 39

the Government, both to ensure sound operation of the financial system as a whole and also to protect individual policyholders.

Question 40

The three regulatory bodies in the UK are:

Answer 40

the Financial Policy Committee (FPC), the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA).

Question 41

The PRA has implemented mandatory standard risk reporting in line with …

Answer 41

Solvency II, an EU Directive covering capital requirements and related supervision for insurers. A firm must hold eligible own funds covering its SCR, an amount calculated from an approved risk analysis model of the business that represents cash at risk over a one year period.

Question 42

Co-insurance involves more than one ..

Answer 42

insurer, who each takes a share of the risk.

Question 43

Insurance arrangements that cover only part of a risk are known as

Answer 43

self-insurance programmes.

Question 44

Self-insurance programmes come in a variety of forms and are influenced to some extent by

Answer 44

tax treatment and local regulation.

Question 45

In large organisations, directors may decide to establish a designated fund from which subsidiaries and other units can claim to recover unexpected losses. This is known as

Answer 45

an internal fund.

Question 46

A captive insurance company is one that an organisation has set up …

Answer 46

and owns. It can be regarded as a formal way of managing an internal fund.

Question 47

Some types of organisation share risks between them, with each paying a contribution into a common fund from which …

Answer 47

losses are paid. The contribution is revised regularly to ensure that it is adequate to cover expected costs of losses and administration.

Question 48

Risk transfer can also occur by contracts. There are several types of risk transfer contracts, including

Answer 48

leases, subcontracts, surety agreements, guarantees and waivers.

Question 49

Alternative risk transfer is an instrument that enables an organisation to transfer financial risk to …

Answer 49

a professional risk carrier, other than by way of an insurance contract.

Question 50

Insurance derivatives are a contract to pay an agreed amount of money once a certain level …

Answer 50

of loss incident is reached.

Question 51

Catastrophe bonds are investment bonds that provide a return to …

Answer 51

investors based on insurance type events rather than financial market developments.

Question 52

Organisations should prepare an overall risk financing plan for board approval that matches the organization’s …

Answer 52

resources and mafces best use of all risk financing opportunities available.