Risk Financing Basics: Key Terms and Tools for Effective Management

1. FN 101 – THE LEXICON OF RISK FINANCING BASICS EXPLAINED Wednesday, April 309:00 am – 11:00 am

2. Moderator –Shaun Jackson Director of Risk Management, El Pollo Loco, Inc. sjackson@elpolloloco.com (714)599-5180 Speaker – Scott Silitsky VP Contracts & Risk Manager, ThyssenKrupp Elevator Company Scott.silitsky@thyssenkrupp.com (954)597-3016 Coordinator/Speaker - Barbara Benson Grinnell Vice President, Willis Benson_Ba@willis.com (985)727-4039

3. What to Expect • After attending this session, you should be able to: • Incorporate risk finance terms and tools into your skill set • Understand how to use risk financing assessment tools • Practice effective communication or risk finance concepts

4. Agenda • Introduction • Basic loss development • Loss analysis • Cash flow comparisons of market quotes • Conclusion

5. Basic Loss Development • Purpose: To use the growth patterns of historical losses to predict ultimate losses on policy years that are still open and developing

6. Sources of Loss Development Factors • Industry-provided • Insurance carriers • Rating bureaus • Independent consultants • Actuaries • Organization-specific

7. Casualty Coverage’s • Workers’ compensation • Automobile liability • General liability • Products liability

8. Loss Development Triangles • Types of triangles • Incurred loss development • Paid loss development • Frequency loss development • Per occurrence retention • Limited • Unlimited

9. Incurred But Not Reported Claims • Incurred But Not Reported (IBNR) claims caused by • Delay between occurrence and reporting of the claim • Actual amount for which a claim will settle is unknown • Indeterminate amount of time between a claims first report and when all activity on that claim ceases

10. Sample Company – Loss Run Summary

11. Sample Co. – Incurred Loss Triangulation - WC

12. Sample Co. – Incurred Loss Triangulation - WC = 24 month incurred losses 12 month incurred losses 578,368 402,087 = = 1.438

13. Sample Co. – Incurred Loss Triangulation - WC Average all policy years

14. Sample Co. – Incurred Loss Triangulation - WC Remove any “irregular” averages

15. Sample Co. – Incurred Loss Triangulation - WC 36 month cumulative average X 48 month incremental average 1.823 X 1.126 = 2.052

16. Sample Co. – Incurred Loss Triangulation - WC 84 month cumulative avg. 24 month cumulative avg. 2.184 1.408 = =

17. Sample Co. – Incurred Loss Triangulation - WC 1 / development factor = 1 / 2.184 = 45.8%

18. Sample Co. – Paid Loss Triangulation - WC

19. Sample Co. – Frequency Triangulation - WC

20. Discovery and Payout Patterns • General/products liability • Slowest patterns • Longest tail because of investigation, litigation, and time lag between report and occurrence date • Workers’ compensation • Payout increases steadily over time • Benefits are statutorily defined • Duration of injury and amount of medical treatment unknown • Automobile liability • Relatively quick patterns • Relatively no lengthy litigation

21. Loss Analysis – Forecasting and Ultimate Liability Analysis • Ultimate liability projections • Adhere to FASB and GASB requirements regarding contingent liabilities • Loss forecasting • Part of the budgeting and marketing process

22. Sample Co. – WC Remaining Liability Projections

23. Sample Co. – WC Loss Forecast

24. Sample Co. – WC Loss Forecast Excluded

25. Risk Financing • Determining the most cost-effective way to pay or fund for losses

26. Risk Financing Continuum Guaranteed Cost Large Deductible Qualified Self-Insurance Captive Risk Transfer Risk Retention

27. Risk Financing Continuum Guaranteed Cost Large Deductible Qualified Self-Insurance Captive Risk Transfer Risk Retention

28. Large Deductible • Loss retention plan • Excess insurance covers losses above deductible • Positive cash flow • Ability to influence program costs • Access to insurer services • Collateral requirements • Tax deduction disadvantage

29. Qualified Self Insurance • Formalized retention program • Excess insurance purchased for losses exceeding limit • Qualification requirements vary by state • Positive cash flow • Ability to influence program costs • Unbundled services • Administrative requirements

30. Factors Influencing Design of Risk Financing Programs • Expected losses • Market conditions • Corporate philosophy • Risk control commitment • Financial position • Geographical locations • Loss payout patterns • Effective tax rate • Corporate ownership • Cash flow comparisons

31. Cash flow Comparisons • Definition: Using the net present value of alternative market quotes to determine the most cost-effective program

32. Present Value Analysis $ today is worth more than $ tomorrow because of investment income implications.

33. Investment Income • Fund losses at a discount, additional money will be added as interest is earned • Varied by program and payout • One decision tool to select the ideal program

34. Tax Implications • Need to consider when the losses and premium can be deducted from taxable income • Different programs are treated differently • Should involve corporate tax department

35. Costs Included • Expected losses • Primary and excess premiums • Claims handling • Taxes • Assessments • Loss Control • Broker fees • Collateral • Fronting costs • Residual market loads • Boards and bureaus • State funds

36. Case Study • Compare the net present value of the following programs • Guaranteed cost • Self-insurance

37. Sample Co. – 1/1-12/31/14 WC Guaranteed Cost Cash Flow

38. Sample Co. – 1/1-12/31/14 WC Self Insurance Cash Flow

39. Sensitivity Analysis • How do optimistic and pessimistic loss projections alter the net present value decision of the various program alternatives?

40. Sample Company – Net Present Value Cash Flow Comparison

41. In Conclusion… • Key Points • Loss development • Loss analysis • Cash flow comparisons • Questions • Please complete the session survey on the RIMS14 mobile application.