Alternative risk transfer solutions are in high demand
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A year and a half ago, the world at large entered uncharted territory. The nature of the pandemic heightened our risk awareness and the shift in our daily lives put corporate resilience at the top of the list for every risk manager and broker. A large portion of our already intangible world shifted exclusively online, creating new risks and exposures.
At the same time, market conditions continued to harden, driving the demand for innovative alternatives to traditional risk transfer. Parametric insurance, risk retention options and other structured solutions that allow for hyper-customisation of insurance programmes have seen a surge of interest in today’s market.
Thanks to vaccine rollouts and fiscal stimulus from governments across many countries, the global economy has started to recover, giving a boost to the insurance market. According to the Swiss Re Institute, insurance premium growth is forecast to reach 3.3% in 2021 and 3.9% in 2022, surpassing $7trn for the first time ever and a 10% increase on pre-pandemic premium levels.
Rising risk awareness
Such premium growth is the result of rising risk awareness as well as the strongest rate hardening and capacity tightening seen in 20 years in non-life insurance commercial lines – two trends that have been accelerated by the Covid-19 pandemic and the economic uncertainty that has come with it.
The last 18 months have also exposed the shortcomings of traditional insurance products – protection gaps, lack of contract certainty, delays in claims payments, rising premiums and a lack of flexibility.
The hard market started before the pandemic as we saw capacity and price go up for cyber and natural catastrophe lines. A typical market cycle hardens roughly once every ten years. In the past, a hard market would average about six months and then would start to soften again.
However, this latest market hardening is likely to be longer lasting. The economic implications of the low interest environment as well as the effects of the pandemic are still to be seen. Meanwhile, political uncertainty in many parts of the world has intensified and extreme weather events have continued to wreak havoc.
A softer market environment and a few fortunate nat cat loss years resulted in risk transfer complacency and a wider protection gap. The pandemic has led more risk managers to review their exposures and needs to address the shortfalls in their traditional programmes. Business interruption caused by risks in the supply chain is a classic example of an area that has historically been vulnerable and underinsured, and plays a critical part in organisational resilience.
One way to reduce protection gaps is through parametric or index-based insurance, where a specified payout is based on a pre-agreed trigger event. These policies have traditionally been purchased by companies exposed to natural catastrophe risk where wind speed (for tropical cyclones) or shaking intensity (for earthquakes) act as triggers.
Today, parametric indices go beyond nat cat risks. We have structured coverage around machinery breakdown, industrial internet of things algorithms and supply chain disruption as ways to reduce the basis risk of traditional insurance and help our customers recover faster after a business interruption event.
This certainty is much more in demand in the current volatile environment and can also be provided by insurers through multiyear and multiline structured solutions that provide price stability and guaranteed capacity over a longer term, making traditional insurance work more efficiently.
Furthermore, such a structure provides clients with more familiarity with the underlying scope of cover and policies, and removes additional budget requirements that come with the annual renewal. Structuring such policies for several years and across multiple lines of business helps reduce the protection gaps over time, as it combines coverage and diversifies potential losses.
The hardening market and the economic impact of the pandemic have also led more companies to look at self-insurance and the use of captives where possible, especially for hard-to-place risks such as D&O, cyber, extended warranties and other emerging risks.
The use of captives has become more sophisticated in recent years and is no longer seen as a vehicle to reduce tax liabilities but rather to better manage and control risks and how they are financed. However, self-insurance does create financial risks for companies without a large balance sheet, especially in such an unpredictable economic environment.
For companies exploring the use of self-insurance, but perhaps lacking capital or infrastructure to administer a full captive, a virtual captive offers a streamlined risk retention alternative. Similar to a few solutions described earlier in this article, a virtual captive is also a multiyear insurance agreement that allows our client to take on more risk over time.
We take care of the administrative and regulatory part (for a fee) and provide stop-loss cover excess of the client’s risk appetite; the client gets to see if risk retention works for its strategy, while keeping the risk off its balance sheet. In the event of no or lower-than-expected losses, they are entitled to collect a loss experience return (‘low claims bonus’) at the end of the agreement. Unlike a full captive, this option is also easier to exit – upon the end of the agreement, the client simply decides whether to renew or not.
Whether the demand for these solutions continues to surge or slightly wanes as the world moves forward, the flexibility, customisation and rapid responsiveness of alternative risk transfer solutions are here to stay. Such innovations have become indicative of the way that insurance will develop in the future, where our customers’ assets are largely intangible, networks and exposures are global, and each risk profile is unique.
Helping our customers define the actual problem they want to solve is key in building the most efficient insurance programme. Solutions designed to meet the specific needs of each client that are also sustainable and dynamic in today’s changing market conditions help insurers to make our customers – and the world – more resilient.
Originally published in Commercial Risk’s Global Risk Manager on 21 September 2021.