Risk financing is financing strategy used by businesses that involves figuring out how to cover risks in the most cost effective way. The purpose of structuring financing in this way is to attempt to prevent the company from assuming too much risk, yet still allowing the company to take on enough risk to grow. Insurance companies commonly use risk financing.
An insurance company can become overexposed to risk if it writes too many insurance policies for a given period without having enough cash reserves on hand to cover them. In such a case, the insurance company could potentially become insolvent if a major disaster happened and many people file claims at once. Risk financing attempts to prevent situations like this. It does this by having professionals try to analyze risk so that insurance companies only assume risks that they can manage safely.
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