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?
