The persistent hard market situation, the imminent renewal of insurance programs at the end of the year, a pallet of emerging risks for which the traditional insurance solutions are not always effective and an increased market volatility; all these elements make these current times best for comprehending the way that Structured Insurance and Alternative Risk Transfer Solutions function. ANRA, the National Risk and Insurance manager Association of Italy, and AGCS (Allianz Global Corporate & Specialty) have discussed these topics in their recent webinar.
Insurers have not only tightened the underwriting conditions but are also demanding companies to rise their retention rates and self-finance their risks. For the complex risks such as cyber risks, risks referring to the supply chain, political risks and risks connected to terrorism, non-traditional solutions are required.
The first step is understanding the basic concepts. The elements that distinguish alternative (re)insurance from the traditional (re)insurance are the reasons for buying the product: risk sharing, not risk transferring, as well as the reduction of the P/L volatility.
Risk financing is a form of debt financing in the form of insurance, which brings administrative advantages (as opposed to traditional debt financing). In case of an adverse event, the loss is liquidated, and the resulting economic impact is spread over multiple years. Through structural features like aggregated limits, sub limits, aggregate deductibles, added premiums and extensions, ART solutions of this type are looking to fund the first loss during a multiyear period, positioning themselves as a second/third risk.
Authorities state that, in order to consider risk insurable, it is necessary to demonstrate that the eventual damage is economically quantifiable. The uninsurable risks from an economic point of view can be managed with an ART solution, under the condition they are insurable from a legal point of view. A risk which is difficult to estimate (without any available information), cannot be transferred, but by using an ART solution it can be identified and financed in time, a condition that can be combined with risks that can be calculated and for which a transfer of sufficient risk is established.
In addition, a provision can only be recognized on the balance sheet when a liability exists, like a present obligation arising from past events, if payment is probable, and if an amount can be reliably estimated. Finally, for a contract to be considered (re)insurable at an accounting level, the (re)insurer must take at least 10% of the probability of incurring a present value loss equal to 10% or more, where the percentage is calculated on the ceded premium.
One (re)insurance solution considers the transfer of the volatility of the profit/loss to the insurers balance sheet, who optimizes the cost of capital (ex. Through a captive), provides financial stability and supports the increase of capacity while retaining the risk.
One of the most interesting ART solutions these days are virtual captives. Whereas a traditional captive is set up as a (re)insurance company within another company, a virtual captive is set up as a multi-year contract with a licensed insurance company. Some of the main advantages of a virtual captive are the non-requirement of an initial capital injections, greater risk retention capacity, and the fact that it allows better planning and budgeting.
In conclusion, using forms of structured insurance and ART solutions brings several advantages to a company. It allows for greater risk retention despite not having a captive, enabling better management of the market cycle through a standby cash reserve. It provides coverage for particular risks excluded by traditional policies through the combination with calculable risks. Finally, it allows the company to develop its retention capabilities over time such as low claims bonuses, return premiums and coverage extensions, as well as allowing for better budget planning and structuring.
Article © Commercial Risk Europe.
