This is the final article, in a three-article series, that discusses the risk financing guidelines set forth in the Standards Australia/Standard New Zealand Committee OB-007, Risk Management Handbook (“Standards Handbook”). This third article sets forth what is effective risk financing as identified in the Standards Handbook.
First, it is important that the organization’s risk be correctly assessed in order to avoid uncertainty regarding the amount of money the risk financing arrangements must deliver and when. If the risk is not correctly assessed, other parties involved in the risk financing arrangement may choose to either not participate or to seek a higher price to minimize their risk.
Second, other parties involved in the risk financing arrangements must be able to meet their obligations throughout the entire term of the risk financing arrangement. Therefore, it is important that the financial strength of the other parties involved be scrutinized as well as their expertise in assessing their exposure to a single catastrophic event.
Third, the risk financing arrangement should be set forth in a legal and binding agreement that accurately reflects the intent of the parties. Thus, the wording of the risk financing arrangement must be carefully reviewed and vetted by experts. If the risk financing arrangement involves an insurance policy, the wording of the insurance policy should be reviewed to make sure that there are not any gaps in coverage.
Fourth, the selection of risk financing arrangements should take into account opportunities to reduce both the scale and likelihood of any risk through prevention or protection measures, as well as the impact on other parties to the risk financing arrangements.
Fifth, it is important that other parties to the arrangement have a correct understanding of the risks. To that end, detailed factual information should be provided and the risks clearly explained.
Sixth, organizations should use experts (external advisors) to provide frank advice to assist with putting in place an effective risk financing arrangement. Those may include insurance and reinsurance brokers, attorneys for legal drafting of risk financing instruments, and global credit rating agencies.
Seventh, the likelihood of timely payment in the event of a loss and the submission of a claim should be considered. For instance, if insurance is part of the risk financing arrangement, consider who the insurance carrier is and whether their claims department is difficult to deal with when presented with a claim.
Finally, it is difficult to predict risk financing costs over more than one year. Sudden large-scale events (the 2008 global banking crisis, the 9/11 terrorist attacks, tornados, earthquakes, etc.) can cause rapid changes in both price and available risk financing capacity. Organization should keep an eye on local and global financial information and be willing to make changes to their risk financing arrangements to counter adverse movements. Organizations may also want to consider using multi-year and multi-line arrangements to lock in favorable risk financing arrangements.
The foregoing just scratches the surface of the discussion of effective risk financing discussed in the Standards Handbook. I encourage you to read Mark Siwik’s interviews of Roger Estall and Roger’s involvement in the creation of the Handbook on Risk Financing. In addition, the Risk Financing Guidelines can be obtained online.