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?

Risk Financing:

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.

Risk Retention:

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?

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Arnold Smith

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