DEFINITION of 'Alternative Risk Financing Facilities'

Alternative Risk Financing Facilities is a type of private insurer that offers various types of coverage to both individuals and institutions. These insurers were originally created by groups of people or organizations that had a common need for a type of coverage that was not available commercially. In most cases, these same parties supplied the initial start-up capital to fund these facilities.

BREAKING DOWN 'Alternative Risk Financing Facilities'

Alternative risk financing facilities can provide several different types of coverage, such as property-casualty insurance, worker's compensation, directors and officers liability insurance and medical malpractice coverage. A wide variety of types of insured employ these facilities for coverage, such as banks, medical professionals, manufacturers and public entities. The majority of the headquarters for these entities are located in Bermuda.

Huge Market for Alternative Insurance

According to actuarial consultant Perr & Knight, this type of insurance has skyrocketed in recent years to more than 50% of the commercial insurance market. "The reason for this shift becomes obvious when one looks at the nature of insurance. Insurance is based on the pooling of risk so those with good loss experience are forced to support those with bad loss experience. As the better risks become frustrated with this scenario and leave the standard market, the remaining pool becomes worse and worse – and standard market premiums rise to reflect the deteriorating quality of the pool."

This is the equivalent of all the drivers in your state with perfect driving records getting together and forming their own auto self-insurance company. The rest of the drivers in the state may find their premiums going up out of control in this situation.

Here are some of the reasons this type of insurance is growing, according to Perr & Knight. "Reduced reliance on commercial insurance allows for the reclaiming of control over risk financing; reduction in the cost of risk management through the lowering of insurance acquisition expenses; stabilization of pricing over time; provision of coverage where otherwise unavailable or unaffordable; access to reinsurance markets; improved cash flow benefits; reduction of government regulation and interference through proper choice of captive domicile; ability to customize insurance programs; formalize the allocation of deductibles for self-insurance retentions within a corporation; better risk management through greater access to claims and underwriting data; improved claims handling and control through implementation of tailored policies and procedures; creation of a profit center; potential tax advantaged treatment of accumulated underwriting and investment income; and ability to direct investment options."

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