Alternative Risk Financing Techniques and Basic Actuarial Loss Projections
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Transcript of Alternative Risk Financing Techniques and Basic Actuarial Loss Projections
Alternative Risk Financing Techniques and Basic Actuarial Loss Projections
Jacqueline Friedland, Actuarial Practice LeaderKPMG LLP
Phone: (416) 777-8320, Email: [email protected]
CONFERENCE
PRESENTS
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Organization of Presentation
• Introduction of alternative risk financing techniques (also referred to as alternative risk transfer or ART)
• Discussion about self-insurance
• Detailed description of four alternatives
• Loss projection techniques and actuarial analyses
• Key steps
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Introduction of Alternative Risk Financing Techniques
• Commonly used alternative risk financing techniques– Funded deductible program– Self-insurance fund– Captive insurer – Reciprocal insurance exchange
• Major decision: whether or not to self-finance (i.e., self-insure)
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To self-insure or not to self-insure?
• What is self-insurance?
• Considerations in deciding whether or not to self-insure– Availability and pricing– Cost effectiveness– Tailor-made solutions– Enhanced risk management– Control
• Characteristics conducive to self-insurance
• Critical success factors for self-insurance
• Disadvantages of self-insurance
• Importance of reinsurance and/or excess insurance
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Major decision: Is self-financing appropriate?
• Decision is simply a financing or operational decision
• Key decision: Is organization prepared to retain and finance potential losses instead of transferring risk?
• “Through the years, the term “self-insurance” has been used loosely to describe a wide variety of risk financing arrangements through which organizations pay all or a significant portion of the costs of selected classes of their own losses.”1
1 Source: The Art of Self-Insurance by David A. North and Catherine D. Bennett (2002 Sedgwick Claims Management Services, Inc.).
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Examples of Self-Insurance
• Small business purchasing automobile physical damage with a $500 deductible
• Large oil and gas company purchasing property catastrophe coverage with a $1 million deductible
• Associations that pool their risks and pay for members’ losses
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Assume Prefunding – Regardless of Selected ART
• Assume prefunding for expected losses and operating expenses for all four ART techniques
• Prefunding at beginning of each policy year
• Can take form of insurance premiums or contributions depending on nature of techniques
• Many of the drivers for self-insurance relate to assumption of prefunding
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The Drivers for Self-Insurance
• Availability and pricing
• Cost effectiveness
• Tailor-made solutions
• Enhanced risk management
• Control
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Availability and Pricing
• Major motivating factor is dissatisfaction with existing insurance coverage or costs
• Related to insurance market cycle
• Market cycle affects price, cover, limits, etc.
• Restrictions often first noticed in long tail coverages or high-risk exposures and industries
• Primary reason for self-insurance: take control over one’s insurance destiny
• Situations in which commercial market ignores an organization’s favourable loss experience
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Cost Effectiveness
• Reduce long-term costs
• Reduce insurance company expenses
• Retain investment earnings
• Retain underwriting profits
• Greater degree of control in litigation and claims settlement strategies
• Improvement and management of cash flow
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Tailor-Made Solutions
• Often related to lack of availability of required coverages
• Address unique exposures
• Tailor-made solutions include: insurance product, underwriting standards, policy terms and conditions
• Help facilitate change
• Increase underwriting and retention funding flexibility
• Improved loss control efficiency
• Promote greater awareness
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Enhanced Risk Management
• Ability to improve and enhance risk management operations
• Elevation of status of risk manager, and of importance of loss prevention and cost containment programs
• Incentives for more proactive risk control and claims management techniques
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Control
• Often cited as independent benefit
• Increased control over:─ Costs─ Investment income─ Availability of coverage and limits─ Structure of insurance program─ Underwriting standards─ Risk management programs─ Claims and litigation management
• Assists in control of volatility (e.g., avoid premium swings due to market cycle)
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Characteristics Conducive to Self-Insurance
• Require an estimate of expected losses and expenses
• Ideal candidate: high frequency-low severity
• Long-tail lines of insurance also conducive due to retention of investment income
• Comments on general liability (GL)– Long-tail line of insurance– Not typically high frequency-low severity– Litigation is frequent, thus greater uncertainty – Nevertheless, many self-insure GL– Reasons for self-insuring GL: high costs and unavailability of acceptable
coverage, terms and conditions, limits– Excess insurance critical
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Critical Success Factors for Self-Insurance
• Long-term commitment
• Need clearly defined specifics of coverage
• Ancillary risk management services
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Key Considerations and Disadvantages of Self-Insurance
• Increased administrative responsibilities
• Variability in losses
• Pricing of other lines of insurance
• Capitalization requirements
• Excess coverage
• Competitiveness of commercial market
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Funded Deductible
• What is a funded deductible program?
• Choice between pre-determined deductible amounts
• Deductible levels established based on negotiation
• Key determinants of deductible amounts:─ Frequency of losses─ Average value of claims─ Ability to estimate expected losses ─ Cost of risk transfer above deductible
• May have aggregate limit
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Funded Deductible (Continued)
• Risk transfer premium
• Contributions for deductible layer
• Total premiums
• Separate account accruing investment income
• Good first step
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Self-Insurance Fund
• Annual contributions for expected losses and expenses
• Actuaries frequently involved
• Critical requirements for successful operation, well-defined:─ Coverage ─ Policy documents ─ Limits of coverage
• Annual assessments not tax deductible
• No capital and surplus requirements
• Provision for potential of unanticipated large losses in early years
• Excess insurance is important
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Captive Insurance Company
• What is a captive?
• Types of captives─ Single owner/parent captive
─ Group captive─ Industry captive─ Association-owned captive─ Agency captive
─ Segregated portfolio company ─ Protected cell company ─ Incorporated cell company ─ Rent-a-captive─ Sponsored captive
─ British Columbia captives
• Captives and fronting insurance companies
• Regulation and operational considerations
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Reciprocal Insurance Exchange
• An insurance market of reciprocal agreements of indemnity or insurance among persons known as subscribers
• Attorney-in-fact
• Subscribers liable for their share of losses and expenses
• Not-for-profit, tax-free status
• Actuary used for pricing and reserving
• Direct access to reinsurance market
• Operating costs
• Capital and surplus requirements
• Regulatory and financial reporting requirements
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Loss Projection Techniques and Actuarial Analyses
• Types of data required
• Diagnostic analyses
• Multiple projection methods─ Development ─ Expected claims ─ Bornhuetter-Ferguson─ Severity-frequency ─ Stochastic analyses
• Actuarial analyses• Annual contributions• Cash flow projections• Surplus requirements• Financial statement
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Key Steps
• The self-funding continuum
• Long term commitment is critical to success of any self-funded program
• Most important decision – not which ART techniques, but is the move towards self-funding appropriate
• Need to identify stakeholders
• Identify and collect data and information
• Conduct actuarial analyses/feasibility study
• Ascertain the appetite for risk of key parties
• Select and develop program
• Implement
• Monitor
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CONFERENCE
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