DEFINITION of 'Finite Risk Insurance'

An insurance contract in which the insured provides a pool of funds for use as loss reserves and for generating investment income. The insured party pays the insurer premiums that are used to cover losses, and if the insurer does not have to pay losses then the remaining premiums (less fees) are returned to the insured. If losses exceed the amount of premiums than the insured will add more funds.

BREAKING DOWN 'Finite Risk Insurance'

Standard insurance arrangements have the insured transferring a liability associated with a specific risk to an insurer, and for this service the insurer earns a premium or fee. The insurer maintains a loss reserve with its own funds, and is able to keep any income that it makes. Finite risk insurance is an alternative risk transfer type of insurance product, with features of both excess insurance and self-insurance. It allows the insured to spread out payments for losses over time, while also retaining the ability to receive a refund of some of its premiums and investment income in the case that it doesn’t experience the amount of losses that it thought it would.

Companies may use finite risk insurance to cover liabilities that have long durations. While the company may save money by self-insuring for these risks, especially if no losses are actually experienced, a finite risk insurance contract at least provides an element of risk transfer. A company may enter into a finite insurance agreement to cover excess losses over other policies, including its own self-insurance strategy.

Types of risks that companies may use finite risk insurance for include product warranties, environmental or pollution risks, and intellectual property risk. By entering into a multi-year agreement, the insured is better able to match the amount of money it sets aside for liability protection to the estimated liabilities that it expects to face.

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