Robert Byler looks at issues surrounding insurance company/carrier transactions that involve ART or captive structures.

The insurance industry is experiencing a continuing hard market that is characterised by a significant reconfiguration in capacity, company downgrades, loss or at least partial exodus of companies and the tightening of underwriting standards. In such an environment, it is widely recognised that alternative risk transfer (ART) structures and programmes can become a viable alternative for an increasing number of insurance buyers. All the while the growing demand for ART products provides opportunities for specialist US insurance companies.

The willingness of US insurers to act as issuing carriers for ART (including captive- type) programmes has changed dramatically. Many `standard market' carriers and reinsurers that competed for ART business have reduced their presence or withdrawn from the arena. Anecdotal evidence suggests many thought their involvement in the ART market would provide an easy way to make money with limited downside risk. The reality, they discovered, was nowhere close to this. Some clearly did not understand the breadth of work and inherent risks involved in these transactions.

To be a successful carrier for ART business, a company must be willing to assume significant risk on all transactions, develop the needed infrastructure to manage the business, employ experienced personnel to properly handle this unique business, and implement an operating platform that includes well thought out processes with extensive controls and a disciplined audit function. The carrier must be able to coordinate a complex structure that may include a broker, consultant, captive owner, captive manager, investment manager, reinsurers, claim and loss control providers and underwriting manager.

What led carriers to withdraw from the ART arena?
For many insurance companies, ART deals fall outside their comfort zones. These carriers are primarily set up to manage business that is controlled within the organisation, but to successfully entertain ART programmes, a company must be willing to entertain more complex deal structures and involve outside vendors. Most companies do not invest the time to develop the necessary tools, resources and staff to handle this type of business. For some, the result has been a venture into the market and subsequent voluntary withdrawal. Others have been forced out or failed.

In reviewing some of these companies, a recurring pattern emerges: lack of controls; poor management; inexperienced or under- experienced personnel; and overly aggressive growth.

Problem areas include:

  • absence of or insufficient documentation of internal procedures and expectations of external resources;

  • poor management of outside vendors, stressing an infrastructure unable to support so many underwriting managers and third party administrators;

  • ineffective contract management resulting in inconsistent and poorly-worded contracts;

  • inadequate collateral management by failure to acquire, track or maintain appropriate levels, leading to insufficient coverage and exposure to the company;

  • delayed cash flow and high uncollectable amounts caused by failure to pursue collectibles on a timely basis;

  • overly aggressive underwriting offering price, terms and conditions well below market, which produced business that was ultimately not sustainable;

  • systems shortfalls producing data quality issues, regulatory reporting and accounting problems; and

  • lack of expertise in the various disciplines leading to mistakes and miscalculations, the downside results of which grew exponentially.

    How are surviving carriers coping with the difficult market?
    Carriers must deal with an increased level of scrutiny both internally and externally. Due to the widely-publicised insurance and reinsurance company withdrawals and failures, more focus has been put on the business model and strategic plans for ART carriers. Most ART underwriters have needed to address questions such as: "How will we avoid the same problems?" and "Why are we better?" This may lead to more internal focus in the short term, but ultimately should result in a higher level of performance for all participating markets.

    Insurance companies that continue to trade in ART products are receiving a significant increase in submission flow and some may be growing the business more quickly than planned or expected. This situation is straining existing resources and creating service issues due to the sheer volume of accounts. Companies must be careful not to become overburdened and lose control of the business. Unfortunately, not all accounts receive the same attention.

    How does a prospective client increase the likelihood of securing a good review by an underwriter?

    The prospective client should work with an experienced agent or broker well versed in ART products and structures. Good representation to the market is the key to success. In conjunction with its broker, the client must develop a comprehensive and complete submission. Quality information is king! The better the submission, the greater the likelihood that an underwriter will give the account the review it deserves. In addition, the client should be willing to meet with prospective carriers in order for each party to gain the comfort level needed to close a deal.

    What are some of the key issues that face the prospective client?

    As previously mentioned, submission quality is of the utmost importance. Once an account is accepted for review, the focus shifts to the deal. First, the client must be willing to take a significant risk position. Knowledgeable ART underwriters look for the prospective client to participate in a meaningful risk position and share in the profits and losses associated with the programme. This alignment of interests is viewed as a prerequisite for success. In addition, the client must be able to prove that funds are available to post required collateral. This is a problematic issue for many clients. Increasing primary and excess rates, organic growth of accounts, higher aggregate attachment points and tighter credit risk policies create larger GAP collateral requirements. Many clients struggle with securing needed collateral. Our underwriters work with the client and broker to investigate supporting quota share reinsurance (for programmes) and other GAP solutions to mitigate the collateral burden.

    Obviously, the prospective client is facing upward trends regarding pricing, terms and conditions. This is exacerbated by decreasing capacity in the ART arena. It is important that the client is willing to work with the carrier to create programme terms that meet the challenges of the market.

    What should the client look for in an insurance company conducting ART business?

    In my opinion, the first issue to review is the experience of the people within the company. A company must have sound ART expertise in order to work successfully with the client to design the proper programme structure for the individual deal. Insurance and reinsurance professionals with strong ART backgrounds manage our group, and we have recruited individuals who fit that profile.

    Secondly, the company needs the staffing and support necessary to provide proper documentation of the deal, policies and contracts, timely review and monitoring of receivables, cessions, premium and loss reporting, claim handling and other service activities. The company that has the expertise, infrastructure and processes in place in this regard is well positioned to achieve the mutual objectives of the parties.

    Thirdly, the prospective client should review the company's financial position and assess the depth of its commitment to the ART market. And finally, cost for services is always a consideration.

    By Robert D Byler

    Robert D Byler is chief executive officer of Alea Alternative Risk, based in Rocky Hill, Connecticut. He has over 20 years of reinsurance and insurance experience and has worked exclusively in the alternative risk area since 1984.