Alternative Risk Financing Facilities

 Alternative Risk Financing Facilities

Investopedia / Theresa Chiechi

What Are Alternative Risk Financing Facilities?

An alternative risk financing facility is a type of private insurance created and funded by its customers to provide coverage tailored to their needs. They were originally formed by groups of people or organizations with a common need for a type of coverage that was not available commercially, but the concept is now being adopted more widely.

Key Takeaways

  • Alternative risk financing facilities are private insurers that offer coverage for a closed group of customers with similar needs.
  • Alternative risk financing facilities may be used to insure against a broad range of risks including medical malpractice, workers' compensation, and officers' liability.
  • Such facilities are increasingly being adopted instead of conventional commercial insurance policies.

Understanding Alternative Risk Financing Facilities

Alternative risk financing facilities are increasingly being adopted as a way to control insurance costs and obtain coverage that is customized for the requirements of a specialized business. They may be used to supply property-casualty insurance, worker's compensation, directors and officers liability insurance, and medical malpractice insurance.

The type of businesses that might create such facilities include banks, medical professionals, manufacturers, and public entities. This consortium of businesses becomes a closed pool of clients for insurance purposes.

In most cases, the insured parties supply the initial start-up capital to fund the facilities.

The Market for Alternative Insurance

According to actuarial consultant Perr & Knight, the number of businesses adopting this type of insurance has skyrocketed in recent years to more than 50% of the commercial insurance market.

Here are some of the reasons this type of insurance is growing, according to Perr & Knight:

  • It eliminates reliance on commercial insurance, allowing a business to reclaim control over its risk financing.
  • It lowers insurance acquisition expenses.
  • It can stabilize insurance pricing over time.
  • It can provide coverage that is unavailable or unaffordable elsewhere.
  • It allows access to reinsurance markets.
  • It provides cash flow benefits.
  • It allows for greater customization of insurance.
  • It improves claims handling and control.

About Commercial Insurance

Conventional commercial insurance provides a wide risk pool. The premiums paid by businesses or individuals with low risks and those with high risks are pooled together to allow for reimbursement of claims by any and all participants. By its nature, commercial insurance uses the resources of its best customers to repay its worst customers.

As a closed group, the risk financing facility focuses on the specific risks associated with a specialized business segment or group.

Other Options

The risk financing facility is one choice for businesses among several in the growing field called alternative risk financing.

The best known is self-insurance, which requires a business to establish a fund to draw upon as needed to meet losses. Another is the captive insurer, an insurance company that is wholly owned by the business or businesses that it covers.

The alternatives are about cutting out the middleman in the insurance transaction. Generally, they are best adapted to large businesses or to a consortium of small businesses with similar interests since they may require a greater up-front investment.

Article Sources
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  1. Perr & Knight. "Alternative Risk Finance," Page 2. Accessed Dec. 3, 2020.

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