Pre-Loss vs. Post-Loss Funding
A large decision for any enterprise or individual is whether to retain risk, finance risk, mitigate risk, transfer risk, etc. What techniques is your enterprise using from the 5 Steps in the Risk Management process? What is your exposure to loss? What is your threshold to loss?
Once you figure these plans out, then it’s time to start thinking about Risk Financing techniques, and topics like Pre-Loss vs. Post-Loss Funding. We see evidence of these decisions at the C-level executive and board level regularly from sources like the Wall Street Journal Risk and Compliance Journal. This is why we think – Insurance expertise is required in the boardroom.
In the event that you decide to retain risk via a deductible or retention, you will come across the question: Pre-Loss vs. Post-Loss Funding -which is best for us and our capital structure?
The main difference relates to when the cash is set aside or raised to pay for the expected loss.
- Pre -Loss financing is cash raised in advance of the loss event
- Post-Loss financing allow firms to pre-negotiate a means of raising cash specifically to cover the loss event
The benefit /cost trade-off for the enterprise and expected opportunity costs associated with the pre-loss funding must be considered.
The opportunity cost to each firm will be evaluated on a case by case basis.
Some questions to consider:
- What is your Cost of capital?
- How would you otherwise use the cash?
- What is your Internal Rate of Return (IRR)?
- Where will you keep the cash? What is your low risk asset strategy? What is this asset returning?
- How does this return compare to investing in Property, Plant, Equipment (PP&E)?
- What are the accounting impacts?
- What are your liquidity or cash flow risks?
- What are the short term, medium term, and long term implications of the decision?