Risk insurance is typically purchased by many types of businesses that need to have a specific type of commercial insurance product. This can include reinsurance, contingent financing as well as using a risk. Alternatives to traditional risk insurance include transferring, financing as well as transforming risk using Alternate Risk Transfers. Alternative Risk Transfers began to become popular alternatives to traditional risk insurance during the 1990s.
- The use of reinsurance as an alternative risk transfer option accounts for 35 to 40 percent of the traditional business market. A reinsurance arrangement is considered a contract and is usually not subject to the various state laws and policy forms that exist for the regulation of traditional insurance products. This means that a reinsurance company is free to develop custom products that can be tailored for a specific type of risk.
- When a risk is transferred from one entity to another, the entity to which the risk is shifted becomes responsible for financing any losses that occur. The most common type of risk transfer involves the use of a reinsurer. A business or entity can transfer various types of risks to multiple reinsurers if a risk is too big for one reinsurer to afford. The main client for a reinsurer is typically a primary or traditional insurer, but large corporations are included as well.
- The retention of risk is a form of financing risk that involves unfunded retention as well as funded retention. These forms of retention require the financing of insured losses when they actually occur or happen. Unfunded retention refers to the financing of retained risk as losses are incurred on an individual basis. Funded risk refers to having funds specifically available or set aside to allocate for particular types of losses that occur.
- Self-insurance is the funding of risk by an entity or firm that has reserves set aside that can be allocated when a loss occurs. When a firm decides to self-insure risk as an alternative to purchasing, an insurance product needs to be considered a cost of doing business. This means that specific losses that could occur need to be factored into the investment decisions that are made. This includes having funds that are liquid and can be easily transferred to cover specific types of losses.
- The use of reserves is another type of alternative to risk insurance that is similar to self-insurance and that requires the use of risk capital. Reserves are similar to self-insurance but lack two key features that differentiate the two. One feature of reserves is that they can't be restricted to being used to cover only certain types of retained risks. Another feature is that the type of risks for which the reserves are kept are generally not known.
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