Alternative Risk Transfer Solutions for Industry and Market

Alternative risk transfer solutions are not just for big corporations; they're also being adopted by small and medium-sized businesses to manage their risks and protect their assets.

Companies like manufacturers and construction firms are turning to alternative risk transfer solutions to mitigate risks associated with product liability and construction accidents.

These solutions can be more cost-effective and flexible than traditional insurance policies, allowing businesses to tailor their risk management strategies to their specific needs.

By using alternative risk transfer solutions, businesses can also reduce their reliance on traditional insurance markets and gain more control over their risk management.

Alternative risk transfer offers numerous benefits and advantages to companies. This approach allows for cost reduction and simplified administration, providing protection at a low cost.

Many companies can reap benefits from implementing alternative risk transfer programs, especially those that consolidate risk through instruments like enterprise risk management programs. This can lead to a more predictable market from risks and stability.

The advantages of using alternative risk transfer include diversification through the finance or transfer of risks, tax benefits, and a low cost to companies in different industries.

Cost reduction and simplified administration are key benefits of alternative risk transfer. This is achieved through the merger of risk transfer and retention, resulting in protection at a low cost for both insured and insurer.

Many companies can reap benefits from alternative risk transfer programs, especially those with enterprise risk management programs. These programs can consolidate risk and reduce costs.

Alternative risk transfer programs are less influenced by market fluctuations, providing stability and a more predictable market for risks. They also attempt to cover non-traditional exposures and risks, especially those that are large in cost.

One of the drivers of alternative risk transfer is the desire to reduce taxes and costs, although this can come at the cost of high transaction costs.

Return on investment is a key benefit of alternative risk transfer (ART). With ART, companies can improve their financial management by altering the perception of risk and even achieve tax efficiency.

ART transactions can attract new capacity for the transfer of conventional risks, or at least manage the retention of risk if the usual sources of capacity are exhausted. This is especially true in the wake of pricing shocks or lack of availability of cover.

By redefining a provision or contingent liability as an insurance premium, ARTs can accelerate tax deductibility. This is a great example of how ARTs can improve financial management.

ARTs can help companies reduce the cost of capital for a project by transferring some of the uncertainties of success, or ring-fencing the credit exposure. This can be a huge advantage for businesses looking to manage their risks.

ARTs are often used as enablers to financial transactions, allowing companies to achieve important objectives like regulatory arbitrage between banking and insurance markets.

Alternative risk transfer (ART) comes in many forms, each with its own unique benefits and applications. One type of ART is a captive, a subsidiary created to insure the exposures of its parent company. Captives can be owned by a group or a single parent and can help companies fund non-insurable risks, retain more risk, and stabilize costs over time.

A captive can be a cost-efficient solution, especially for emerging risks that are difficult to insure due to data scarcity. By using a captive, companies can finance risks, gather data points to build an underwriting model, and attract external insurance capital over time. This can be particularly useful for companies that may not be able to insure their exposures in traditional markets.

Another type of ART is parametric insurance, which works on an "if-then" basis, tied to a pre-defined event triggering an agreed payout rather than a traditional claims adjustment for actual loss sustained. This type of insurance is often used to cover emerging risks, such as natural catastrophes, cyber attacks, and supply chain disruptions. Parametric insurance can provide liquidity and help companies manage business continuity.

Here are some key characteristics of different types of ART:

Captives are a type of alternative risk transfer that has gained popularity due to their ability to help companies fund non-insurable risks and retain more risk.

Twenty-five percent of respondents in Aon's latest Global Risk Management Survey reported using a captive, up from 17 percent in 2021. This indicates a significant increase in the adoption of captives as a risk management strategy.

Captives can be tailored to an organization's objectives and risk management approach, making them a flexible solution. They can also be used to finance emerging risks that are difficult to insure due to data scarcity.

A captive can be used to gather data points that can be used to build an underwriting model and attract external insurance capital over time.

Organizations have used captives to configure optimal risk financing outcomes, blending and connecting all available forms of capital to their risk. This can include using advanced analytics to optimize Total Cost of Risk (TCOR).

There are two main types of captives: group captives and single-parent captives. Group captives are formalized pools where several organizations or businesses work together to share exposures and financial costs. Single-parent captives, on the other hand, operate as a formal retention plan and only cover exposures for the parent company and its affiliates.

The capital requirements and start-up costs for a captive can be quite high, with some jurisdictions requiring over $1 million in capital. However, organizations can meet these requirements through a line of credit, depending on the domicile of the captive.

Parametric solutions are a type of alternative risk transfer that provides a straightforward and efficient way to manage risk. They work on an "if-then" basis, where a pre-defined event triggers an agreed payout rather than a traditional claims adjustment for actual loss sustained.

Companies are increasingly turning to parametric solutions due to their transparency, flexibility, and speed of liquidity. This is particularly useful in hard markets like global property, where natural catastrophe losses and other risks present challenges.

Parametric solutions can provide cover for existing and emerging risks, from natural catastrophes to non-physical damage, cyber, supply chain issues, and more. For example, a retailer that sells goods shipped through an earthquake-exposed port can't traditionally insure the port even though shipments could be affected. With a parametric policy, that retailer can cover its losses if a pre-defined level of disruption is reached.

Parametric solutions can also provide liquidity to allow employers to support employees when a natural disaster occurs in their area and wipes out internet access or causes destruction to their town and homes – ultimately helping to manage business continuity.

Here are some key benefits of parametric solutions:

By providing a simpler and more straightforward way to cut through the process, parametric solutions can help companies navigate complex risk management challenges. They can also help companies save more than half their risk transfer costs, depending on their own performance over time.

Self-insurance, also known as retention, is one of the most straightforward Alternative Risk Transfer (ART) techniques, allowing a company to create a system of recording its losses and paying for them. This approach can help organizations save money on premiums and maintain control over the claims process.

Self-insurance can be a cost-effective option, as companies pay with their own cash flow or liquid assets, rather than sending money to an insurer. By retaining some of the risk, organizations can offset potential losses and generate greater efficiency within their operations.

Self-insurance can be particularly beneficial for companies that experience high-frequency losses, as it allows them to finance losses rather than filing a claim with an insurer. This approach can also provide flexibility, as companies are not subject to policy conditions and exclusions.

Companies that opt for self-insurance often purchase an excess coverage policy for sporadic but severe losses. This can help mitigate the risk of unexpected events and provide an added layer of protection.

By exploring self-insurance as an ART technique, organizations can gain a better understanding of their risk strategy and identify areas for improvement.

Reinsurance is a risk transfer technique that allows insurers to transfer some or all of their exposures to a reinsurer, providing an added layer of protection, especially for catastrophes or "Acts of God".

Reinsurance agreements set the terms for covered losses, but insurers typically retain a certain percentage of their insurance amount or dollar amount of loss. This means the reinsurer doesn't assume all liability, but rather shares it with the insurer.

Reinsurance benefits both the insurer and the insured by providing surplus relief to insurers and increasing the line capacity of liability or property coverage.

Alternative risk transfer (ART) products offer a range of solutions for managing and transferring risk. These products can be categorized into two main groups: uncommon mediums used for common risks and mediums based in capital markets.

Some examples of uncommon mediums used for common risks include Risk Retention Groups (RRG), where several companies contribute capital to self-insure, and Self-Insured Retentions (SIR), where companies set aside capital to cover losses.

Here are some examples of ART products that are mediums based in capital markets:

Alternative risk transfer (ART) solutions offer a high degree of customization, allowing businesses to tailor their risk management to their unique needs.

Companies can choose from a variety of mediums to transfer risk, including self-insurance, captives, and finite insurance policies that can be structured to meet specific requirements.

For instance, a retail organization facing high property risk transfer costs can implement multi-year solutions based on actual loss experience, allowing them to manage their risk more cost-effectively.

A customized ART solution can also provide coverage for multiple risk lines and/or with multi-year terms, enabling businesses to optimize their risk management strategy.

Businesses can choose from a range of policy-making options, including risk retention groups, self-insured retentions, and earnings protection policies.

Here are some examples of customizable ART solutions:

Ultimately, customization is key to an effective ART solution, allowing businesses to align their risk management strategy with their unique needs and goals.

Forest fires can be devastating for forestry companies, especially in Latin America where they're a common occurrence. A global commercial forest owner in the region experienced exceptional fire losses that exceeded their insurance policy limits and market capacity.

WTW worked with the company to develop an innovative Burned Area Index alternative risk transfer solution. This solution incorporated NASA satellite imagery data and an agreed asset-based value per pixel on given images.

The solution provided the capacity the business needed at an efficient premium and allowed for timely and efficient payouts. Payouts were calculated independently using a pre-agreed formula.

Here are some key features of the parametric solution:

Parametric solutions like this one are becoming increasingly popular in the industry. They offer a simpler and more straightforward way to manage catastrophe risk, and can provide faster payouts than traditional insurance.