Strategy

Special Report: Choosing Self-Insurance

In the face of perils like terrorism, climate change and world economic downturn, finance chiefs need to get a handle on how to deploy self-insurance.
David KatzJune 24, 2014

How much risk should your company retain, and how much should it transfer to an insurance company?

14Jun_SRSelfInsurance_IntroGraphicWith the emergence of huge corporate exposures like terrorism, climate change and the risk of world economic downturn, CFOs need to get a handle on the question of whether or not to self-insure — and if so, how much.

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The authors of the articles featured in CFO’s Choosing Self-Insurance Special Report attempt to provide qualitative, quantitative and pragmatic solutions to the conundrum of how to finance corporate risk.  Writing from a qualitative standpoint, regular CFO risk management columnists John Bugalla and Kristina Narvaez contend that decisions about how high a level of insurance deductible for a corporation to retain have too often been driven by the insurance market, rather than the specific financial structure of the organization.

To tie the company’s finance strategy more appropriately to questions of insurance and self-insurance, they contend, finance chiefs should get involved in the risk management process. “Deciding the right level of a company’s insurance deductibles or risk retention depends largely on the organization’s risk appetite and its financial strength — definitely territory for the CFO,” they assert.

But CFOs may do well to use analytics as well as their own insights as a way of gauging how much risk to take on. In another article, Rich Michel, the risk management national practice leader at Wells Fargo Insurance Services USA, sketches out an overarching quantitative approach to corporate risk retention/risk purchasing known as intrinsic risk valuation (IRV).

Much like intrinsic value investing, in which stock analysts set an intrinsic value for a stock and buy or sell based on the difference between the intrinsic value and the market price, IRV is a baseline by means of which CFOs can decide whether and how much risk their companies should retain. “Most companies evaluate the purchase of insurance and other risk-transfer solutions one risk at a time. The amount of risk to be retained by the company is most often weighed against the premium or other savings for assuming each risk,” writes Michel.

“It is less common to find companies that make risk transfer-risk retention decisions based on their entire portfolio of insurance and other risk-transfer solutions. Doing so however, could help derive the greatest value from the company’s available risk-bearing capacity: its financial capacity and tolerance for taking risk,” the broker thinks.

While such comprehensive analysis can be a great help in setting overall budgets and risk-tolerance levels, however, CFOs and risk managers still need to figure out what risk-financing methods best suit their companies. One option is to self-insure certain hard-to-place risks through a corporate-owned captive insurance company. Greenberg Traurig tax attorney Jeffrey C. Joy advises, for example, that CFOs should consider the benefits of self-insuring cyber risks and supply-chain business-interruption perils via a captive as a supplement to their companies’ commercial insurance coverage for such risks.

“Adding comprehensive or supplemental cyber risk and business interruption coverage through a captive should be considered an important contingent component to any company’s strategic risk management plan,” Joy writes. “These risks are real for most companies, and the potential damages to a company’s revenues and profits can be significant.”