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INTRODUCTION

Risk financing refers to arrangements to ensure the availability of funds, where needed, following the occurrence of an unintended event.

Implemented effectively, risk financing may lessen the effect of the event upon achievement of the organization's objectives or even create new opportunities. It will be unusual that risk financing can lessen all of the consequences of the event.

The cost of implementing risk financing will reflect the method chosen, its reliability, and the scale of the potential consequences of the risks being financed.

Coherent risk financing arrangements require that risks are accurately assessed and both the need for and parameters of any risk financing determined after considering other treatment options or combinations of options.

Risk financing decisions need to be reached through application of the risk management processes described in AS/NZS ISO 31000, Risk management-Principles and guidelines.

Risk financing methods continue to evolve with some being more complex than others. The cost of any particular method can vary significantly over time - even though the risk being financed is unchanged. This gives further emphasis to the importance of applying the step, Monitoring and Review, within the AS/NZS ISO 31000 risk management process (see Figure 1).

An increase in cost of one risk financing method (e.g. as a result of cyclical movements of global capital markets) can act as a stimulus for the development of alternative methods.

The expertise required to implement various forms of risk financing differs markedly. Small and medium sized enterprises (SMEs), such as those with fewer than 50 employees which constitute 98%* of organizations in New Zealand, will often trade the cost of engaging the expertise needed to implement a particular risk financing measure against any variations in the underlying cost of the method itself.

Whatever risk financing method is selected, the crucial test is that, within an acceptable level of certainty, the method chosen will ensure funds, in the amounts required, will be available when needed.

However, it is not uncommon to find that those responsible for risk financing decisions will subordinate this crucial test to considerations of the transactional cost of the proposed method. Errors of judgement in this respect can have serious consequences. Whereas the costs of risk financing may impact on organizational performance at the margin, risk financing arrangements that do not deliver the funds required when needed, can result in organizational failure.

The central purpose of this Handbook is to-

(a) assist the reader to understand the functions and limitations of risk financing as a type of risk treatment;

(b) provide guidance on risk financing nomenclature and underlying concepts (as they stand at the time of publication);

(c) explain the nature and impact of the dynamic relationship between risk financing and other forms of risk control, the opportunities for this to be exploited and the consequences of it being disregarded;

(d) provide a framework within which to define the risk financing need and select options that meet the above 'Critical Test'; and

(e) offer guidance to those within an organization who are responsible for either implementing or monitoring its risk financing arrangements.

Readers need to keep in mind that risk financing methods, the markets that provide risk financing instruments and regulatory frameworks will continue to evolve. For all of these reasons, this Handbook should not be relied upon for legal or definitive advice.

* Statistics NZ. Business Demography Survey. February, 2008.