Michael Saltzstein on Risk Financing

Risk financing determines how an organization will pay for loss events in an efficient and cost-effective manner. Michael Saltzstein explains it helps identify risks, determine how to finance the risk, and monitor the effectiveness of the chosen financing technique.

Risk financing can assist a company in aligning its desire to take on new expenses to grow the business with its ability to pay for those risks. First, companies must consider the potential costs of their actions and whether they will help the business achieve its goals. Then, the company will examine its priorities to see if it takes on the appropriate amount of risk.

Captive insurance, commercial insurance policies, self-insurance, and other alternative risk transfer schemes are available. However, Michael Saltzstein believes their effectiveness depends on the organization's size, financial situation, and overall objectives. Risk financing seeks the least expensive option but must ensure the organization has the financial resources to continue operations after a loss.

Determining risk financing typically entails a company forecasting the losses they expect to incur over time and then calculating the net present value of the costs associated with the various risk financing alternatives available to them. Each option will likely have a different price, depending on the risks that require coverage, the loss development index most applicable to the organization, and any legal and expert consultation required.

Risk Financing as a Financial Health Indicator

Michael Saltzstein emphasizes that how a company handles situations that necessitate risk financing is a good indicator of its competitiveness and long-term viability. One of the most widely accepted key metrics is Cost of Risk, a quantitative measure of the total direct and indirect expenditures allocated to risk mitigation. While COR usually only includes costs incurred due to insurance activities, COR can also include expenses incurred due to external risk transfer, retained/self-insured losses, or missed opportunity costs.