Post-Loss Financing Solutions for CED PLC

This article discusses the two post-loss financing solutions, self-insurance and commercial insurance, for CED PLC. It explores the advantages and disadvantages of each option and provides recommendations based on the company's current situation. The article also highlights the importance of managing post-loss financing effectively to ensure stability and recovery for the company.

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Introduction
CED PLC is an international manufacturer for aircraft engines. Currently, it requires post-loss
financing solutions due to the defect that transpired in it's recent most launched and installed
engine. As reported by the airlines using the new engine, operational difficulties have been
experienced along with a significant increase in the maintenance costs associated with the
aircraft engine.
CED PLC has reported a defect on its new design with the turbine blades of the engine. The
financial costs for CED include redesign and re-manufacturing of the turbine blades,
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replacement of already installed engines in aircraft and compensation for grounded aircraft
during maintenance.
Currently, CED faces two specific situations. Firstly, it has accumulated extensive debts over
the years in order to deliver and manufacture its engines. Secondly, despite the debts, the
share price of CED has doubled due to the apparent success of CED’s newly manufactured
engine which indicates investor’s expectations of better performance of the company.
Keeping these situations in mind, the two post financing solutions which are under
consideration are discussed in the next section. In this report, the potential financing
solutions are discussed. Furthermore, the advantages and disadvantages associated with
each of the financing solutions are also discussed. Lastly, a recommendation is made based
on the most suitable.
Post-Loss Financing Solutions
The two suitable post financing solutions are as follows:
1. Self-Insurance
2. Commercial Insurance
Self-Insurance
Considering the stance of the company, a suggested form of insurance is self-insurance.
The company has significant debts under its name and therefore, additional premium
payments is a difficult feat, (however not impossible) to achieve given the circumstances.
Self-insurance refers to companies using their own means and methods to resolve and
finance the losses. Currently, the losses are expected to exceed 400 million pounds. That is
a huge amount to be paid through third-party insurance activities. Furthermore, taking on
additional loans can potentially drag the company into bankruptcy and therefore, be fatal to
its existence. However, self-financing its insurance through either income stream portions or
captive insurance can lead to significantly better output and therefore, ensures the
semblance stability and liquidity during its course of financing its losses.
Self-insurance can be followed through by the company due to its doubled share price. The
company can seek further capital by floating additional shares in the market. With the likely
performance boost that the investors have anticipated, should invite more investors to buy
and hold, adding additional capital to use in its financing measures. The company can,
therefore, use the additional capital to finance certain aspects of its losses, namely,
replacement and redesign for its turbine blades, before quantifying and paying for grounded
aircraft. The biggest bottleneck in the financing issue is compensation for aircraft that are
grounded and cause the airlines to suffer extended expenses. The aircraft, longer put into
the grounded state would lead to larger and larger compensation and therefore, put CED in
a difficult spot to come out of. In order to reduce the compensation losses, the company
would need to use available resources to redesign and manufacture replacement turbine
blades on an immediate basis. This portion of the losses can be effectively financed by the
company itself through equity financing. It can discard these losses on the balance sheets as
expenses and remanufacture the blades for immediate sales. It should also look into halting
installation in further aircraft, to limits its exposure of losses to limited airlines.
Moving further, the company can seek to also form a captive insurer that can limit its
exposures to the losses and assist in the financing of the losses. A captive insurer is a form
of self-insurance where the parent company creates another insurance company to finance
its losses. It is useful for companies to do so, considering it allows them to manage their
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finances sufficiently while expanding exposure to another entity. Furthermore, the expansion
comes with premium payments, which are also reduced, and the profits generated from the
insurer can be reaped and utilised by the parent company itself. It is a suitable method of
self-financing its losses through captive insurance for CED PLC. The limitation on its form of
refinancing is that it should use it asses its cash flows such that the compensations are
effectively made to the airlines that are experiencing issues with the installed engines.
Therefore, conclusively, the first solution for post-loss financing for CED is self-insurance. It
can be broken into two portions. Firstly, using equity financing through floating more shares
in the market to attract investors, to finance its redesign and re-manufacturing for the turbine
blades that need to be replaced and reinstalled in the affected aircraft. Secondly, seeking
captive insurer formation to transfer and share its post-loss insurance exposure to an
extended owner, allowing it to mitigate its risk substantially and forming an alternate income
stream for future expenditure and debt repayment. It is suitable for CED PLC to manage its
losses through a self-insurance scheme, or at the very least, use it to minimise its
expenditure.
Commercial Insurance
The commercial form of insurance refers to using a third-party insurer to assist in mitigating
or embracing the losses. Since it is a post-loss financing solution, therefore, the event for
which the insurance is required has occurred, and therefore, the purpose of the insurer
would be to provide financing to the affected parties in this scenario which are CED PLC and
the airlines that were using the installed new engines.
Commercial insurance is a straight-forward process requiring simple assistance from the
insuring party. CED PLC would be required to pay a fixed set of premia payments,
exceeding the cost of financing required, to accommodate for the time elapsed, therefore,
adjustments for time-value of money and inflation. Assuming local clients, the company
would not be exposed to exchange rate or similar overseas risks associated with the
transactions that would fluctuate the cost of repayment. Therefore, the sole line of credit
required through the insurance company would be to compensate for the aircraft of the
airlines that had to be grounded for maintenance and replacement of the turbine blades.
Assuming the company would not be able to sell the replacement blades. Therefore, the cost
of production and manufacturing is something CED would be bearing on its own
expenditure. CED would require financing it's manufacturing through its own income stream,
preferably through its income profits or through equity financing. Debt financing is currently
not an option considering the large amount of debt that the company has already incurred
due to the manufacturing of the engines that were unfortunately found to have an inevitable
defect.
CED PLC does not have the option to avoid the circumstances currently, and therefore
would need to finance the losses since the event of insurance has already occurred. For
future references; however, it should perform stricter quality assurance checks to ensure
such occurrences in future are avoided at all possible cost.
Commercial insurance, therefore, is one of the suitable solutions, as discussed in this report
for CED PLC. It would provide steady support to the current loss situation, allowing it to deal
with the losses proactively. The company can, in future, seek further forms of insurance, for
instance, requiring coverage to compensate its clients in case of such occurrence. Since it is
a low-frequency event with high severity, therefore, a commercial form of insurance is the
best and most affordable form of insurance that the company can employ in future. For the
current scenario as well; however, it is a feasible solution and can be used by the company
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to finance its losses in portions and effectively recover from its financial standstill or potential
decline.
Conclusively, commercial insurance would provide CED PLC with post-loss financing
through premia payments on a regular basis, allowing financing for compensation for the
airlines involved in the defect scenario. Furthermore, the remaining costs of loss can be
financed by the company through its own income stream, equity financing or cuts in the profit
portions generated each year. The cost of manufacturing replacement blades can be
expensed out on its balance sheets as an internal expense.
Benefits and Drawbacks of Post-Loss Financing Solutions
Each of the post-loss financing solutions is the suitable option for CED PLC. However,
despite its limitations and suitability, each of the solutions has its own drawbacks and
benefits associated with them. This section analyses each of these solutions in terms of their
advantages and disadvantages, based on the position CED PLC is currently in. This better
helps understand which solution is considerably better than the other for CED, through
assessing the opportunity cost of opting for each of the solution available, in terms of
analysis of their pros and cons.
Advantages and Disadvantages of Self-Insurance
The following are the advantages of opting for the self-insurance option for post-loss
financing.
Transferable Risk
One of the advantages of opting for self-insurance is the transferable risk. Since the
company will be developing forms of the income stream to mitigate the loss, therefore, some
portion of the losses can be transferred to other parties and therefore, reduction of losses is
possible. For instance, in case of turbine blade replacements, the cost of manufacturing the
blades can be shifted to the affected airlines and therefore, they can be requested to make
partial or complete payments for replacement and installation of the turbine blades in the
affected aircraft.
Less Costly
Since self-insurance relies on the company to internally manage its cash flows such that it is
capable of financing its losses, therefore, it is less costly in terms of financial costs
associated with opting for other products for coverage of post-loss financing through third
party vendors. For instance, insurance can be very costly if acquired through third-party or
any commercial vendor, and therefore, would increase expenses in the form of premia
payments over an extended period of time. Therefore, self-financing through self-insurance
is a cheaper alternative for CED PLC to opt for.
Mitigated Risk
In self-insurance, the risk can be mitigated to another party, therefore reducing the exposure
of the post-loss financing on CED. For instance, the strategy of using a captive insurer is
cheap as well as useful for mitigating loss exposure significantly. It can prove to be a
cheaper and reliable option for CED since the expense of premia is bearable and the
contract is also fairly flexible due to the owner of the captive insurer being the parent
company itself. Furthermore, the income generated from the company can be utilised within
CED as well for financing other losses such as the redesign and remanufacturing of the
turbine blades.
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Following are the disadvantages of opting for self-insurance scheme as a method of
managing post-loss financing:
Uncertainty
In case of opting for risk transfer with another party, there is a certain amount of ambiguity
considering the contract details of the insurance and post-loss financing may not be entirely
clear. Furthermore, there is an added uncertainty that the entity involved may not offer to
completely live up to their part of the bargain, making the use of risk transfer for post-loss
financing considerably risky and uncertain. CED PLC cannot bear to sustain the expense of
the entire post-loss financing on its own. Therefore the added uncertainty can lead to further
risk management requirement and turn out to be more expensive than the actual post-loss
estimated cost.
Loss Bearing
The biggest drawback of self-insurance is that ultimately, the company has to bear the
expenses. The redesign and manufacturing alone would be a significant cost to manage,
followed by replacement and installation. In the worst-case scenario, the involved parties
would not be inclined to pay for replacement blades, hence shifting the manufacturing cost
on CED. The loss bearing would ultimately fall onto CED, forcing it to generate better profits
or income streams, cutting down costs or downsizing in the worst-case scenario in order to
be capable of completely financing its post-loss insurance scheme. Inability to do to so
would greatly impact the credibility of the company and damage the trust of investors in
future product launches.
Reduced Premia Credit
Since the financing would be conducted through a captive insurer, there is a possibility of
reduced credits offered due to risk transfer and limited resources. CED would inevitably be
bearing a major portion of its losses, without the option of acquiring more debt in fear of
eventual decline into bankruptcy. Therefore, the choice of transferring risk is therefore
limited, and at the cost of premium credits offered through the insuring entity for loss control
financing.
Advantages and Disadvantages of Commercial Insurance
Following are the advantages of opting for a commercial insurance solution for post-loss
financing for CED PLC.
Reduced Uncertainty
The biggest advantage of opting for commercial insurance is reduced uncertainty. Since the
insurance company would enter the contract with a commitment to fulfil and finance the cost,
therefore, it would be liable to pay for the losses on the entirety. There is close to no risk of
default from the insuring company. Hence, it is a reliable option for CED to choose
commercial insurance, given its proper coverage of the loss-financing offered.
Value Added Services
Commercial insurance companies are specialised in risk management and mitigation, and
therefore, would be in a better position to offer more specialised services related to post-loss
financing and drafting future underwriting contracts for insurance. It can guide as well to
other forms of insurance that the company can acquire to mitigate future losses more
effectively, allowing CED to focus its resources on manufacturing and product design for
future products rather than crumbling under the expense of losses, pushed to the brink of
bankruptcy.
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Tax Deductible
Taxation form a major expense for most companies and therefore, tax offsetting products
are available, which reduce the tax levied on the income streams. Through commercial
insurance, the income derived from the premium becomes tax deductible expenses and
therefore, reduce the tax levied overall on the company in question. Hence, for CED, it is a
suitable solution considering lower future taxes through the benefit of insurance is favourable
for the company's prospects and risk management.
After the advantages, the following are the drawbacks for CED if it opts for a commercial
insurance solution for its post-loss financing.
Costly in Premia
One of the biggest drawbacks of commercial insurance is the expensive nature of such
products. Commercial insurance, although are commendable in its coverage but are
carefully designed to offer the insuring party significant premium for taking on additional risk
exposure. Therefore, it makes such insurance schemes considerably expensive for the
parties seeking insurance. For CED, if it manages to generate good income and profit
streams, it would be beneficial, otherwise disastrous for it to opt for a commercial mode of
insurance as a post-loss financing solution.
Costly in Time and Efforts
For a commercial product, the contract can be very strict and not flexible to the support of
the insured party. Therefore, it can be fairly costly in terms of time and efforts invested in
finding a good insurance company to sustain and share the risk exposure for the said event.
If the event is a low occurrence event, it would be easy to manage, but since the condition is
post-loss financing, it can be difficult and resource-consuming for CED to find a suitable
contract that can be modified to suit the needs of the company itself, allowing it to share the
losses with the insuring entity.
Negligence on Company’s Behalf
One major cost after opting for commercial insurance that is exhibited by companies is an
attitude of negligence. Since the insuring party opts to share the risk exposure at the cost of
regular premium payments, the insured company may exhibit relaxed attitude towards its
products and lost control due to the fact that the insuring party would be liable in major terms
to repay for the incurred expenses if such circumstances arise. CED PLC currently already
suffers from lack of quality checks, and therefore, this strengthens the likelihood of its
inclination towards negligence and would avert potential insuring clients to offering viable
insurance product due to the company's attitude towards its customer service base.
Recommendation for CED PLC
After discussing the available solutions for CED PLC as post-loss financing solutions for its
engine defect and analysing the advantages as well as disadvantages of each of the
available financing solutions, the recommendation for the company is a commercial form of
insurance.
The compensation for airlines for the grounded aircraft can be offered through sharing the
expense with an insurance company, whereas using equity-based financing to offset the
manufacturing cost and replacement cost of the turbine blades. The commercial solution is
suitable for CED PLC, and therefore, it should proceed with the solution through negotiating
with its potential clients and manage its post-loss financing at the earliest. The compensation
to the airlines is considerably time-sensitive, hence requiring immediate action on behalf of
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CED PLC to reduce possible added future expenses to the current loss situation of the
defected engines.
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References
Books:
Rejda, George E. (2001) Principles of risk management and insurance, Seventh edition,
New York: Addison Wesley Longman, Inc.
Websites:
Advantages of Captive Insurance, Link:
https://dfr.vermont.gov/industry/captive-insurance/become-vermont-captive/advantages-
captive-insurance
Risk Management and Alternative Loss Financing Techniques, Link:
https://coggle.it/diagram/Wsq1OA68PYJ5nKVh/t/risk-management-alternatives-loss-
financing-techniques
The Use of Loss Financing of Catastrophic Risk, Link:
https://www.researchgate.net/publication/228127025_The_Use_of_Post-
Loss_Financing_of_Catastrophic_Risk
Post Loss Financing and Analysis of Business Recovery, Link:
https://www.globalriskexperts.com/direct-client-services/post-loss-analyses-business-
recovery.html
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Recommend with reasons
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