Organizations use two main methods of risk financing to cover their losses - retention and transfer. We compare these two methods.
Retention (retention) means that an organization uses its own resources to cover their losses. The source of funds to cover the losses may be notes of cash, current assets, borrowings or deposits of shareholders in exchange for the right to participate in the organization. The amount of funds required to cover the losses, left on their own holding, is uncertain, so these losses can significantly reduce the net profit of the company, its net worth and cash flow. Speculative risks are left on their own holding, in contrast to pure risk can bring organizations benefit from some positive outcomes of these risks.
Typically, the organization chooses the risks on their own holding, but sometimes this choice is mandatory. For example, car insurance in case of damage: insurers shall establish a minimum level of franchise policy that encourages the insured to participate in the minimum amount of damages. Other types of insurance policies - such as the majority of insurance policies against earthquakes, necessarily contain a condition whereby the policyholder alone covers a fixed percentage of the value of the insured property or losses incurred on each risk.
Transfer (transfer) means that the transmitting entity (transferor) uses the resources of another host (Iransferee) , the organization for payment or offset its losses. An organization that adopts a risk receives compensation in exchange for the payment of future losses on the risk. For the organization, the transmission losses as a result of its speculative risks, the cost of transmission losses compensated partially or completely through some wins that may occur in the event of a positive outcome of these risks.
Compensation (reimbursement) loss arising on the transfer of risks, can take many forms. For example, a company can receive cash benefits directly from the organization accepting the risk. In order to recoup their losses the company may also use a positive change in the value of financial instruments in which it has invested.
For risk hazard the most common method of risk transfer is their insurance. Insurance companies receive premiums in exchange for the payment of compensation by the insurer (or for the benefit of policyholders) in the event of any loss on the insured risk.
Organizations often enter into contracts that are not related to insurance, in order to transfer their risk of loss. For example, shops selling toys at retail, often require their suppliers (manufacturers of toys) to reimburse them for any damages arising from trade toys that are related to products liability. (In this case, difficult to accurately determine the amount of compensation that should be paid the organization that takes the risk, so this requirement becomes an integral part of the transaction between the seller and the manufacturer.)
Another form of non-insurance contract (Contract noninsurance) , which organizations use to transfer risk - derivative security or derivative (derivative) . The derivative of a chain of paper - a financial instrument whose value is based on the value of another asset, called source (Underlying Asset) . To submit your own risk, an organization must buy a derivative security whose value is positively correlated with a specific category of loss organization.
The organization uses a positive change in value of derivative securities to cover their losses. Hedging with derivative securities is most often used by organizations to cover their risks arising from these financial / market risk as currency and interest rate risks as well as risks associated with changes in commodity prices. Hedging can also be used to cover losses on the risks of danger.
Securities with an insurance component (Insurance-linked Securities) - another form of non-insurance contract that organizations use to transfer the risk of danger. Together with the securities and the insurance component of the investor receives the occasional risk of loss associated donated paper. To date, insurance securities exist mainly in the form of catastrophe bonds (BONDS Catastrophe ), used by insurers to transfer their risks associated with disasters.
Note that loans are a form of self-retention risks. Even despite the fact that the funds to cover losses are taken from other organizations (such as, for example, a bank), the borrower must promise to return the funds, and so we can assume that it uses its own funds to cover the losses.
In practice, most organizations to cover losses uses a combination of net retention and risk transfer. In the example, the store vehicles mentioned above, we assume that the organization has bought an insurance policy with a deductible (deductible) . The presence of a franchise is a method of self-retention, so shop car yourself pokryvaetlyubye losses within the franchise and therefore pays for the losses of their own financial resources. Insurance (over the franchise) is a method of risk transfer, where the store pays a premium car and uses the insurer to pay the part of any risk covered by insurance, which exceeds the deductible.
The following describes the various types of retention and risk transfer to finance them. Although all of these plans can be used by large organizations, many of these techniques can also utilize medium sized organizations. The following table compares the methods of retention and risk transfer.
