One definition of intellect is “the capacity for understanding, thinking and reasoning”. This is the starting point for finite risk solutions, write Henry Withinshaw and Stephen Young.
Finite risk aims to provide insurance policies that allow clients to participate in their own good results, while explicitly using future revenues to help pay for losses. These revenues will probably be in the form of additional premiums, investment income or a combination of both. Finite risk is not an alternative to the traditional insurance market, and does not produce substitute products. Finite risk insurance is a complimentary tool to provide long-term stability and growth. It is transaction specific, client specific and nearly always balance sheet specific. When you look at finite risk as a separate discipline, it all starts to make much more sense.
What does finite risk offer?
Finite risk offers insurance and reinsurance solutions to balance sheet and capital problems. Although there are many different reasons for a finite risk policy, it is fair to say that the majority today create economic stabilisation over the long term. The goal is consistent results and growth, for both the reinsurer and our clients. Economic stabilisation as a goal applies equally to corporate clients as it does to insurance companies and Lloyd's syndicates. The team of employees within a finite risk carrier will frequently consist of actuaries, accountants and financial analysts as well as underwriters. These are the “intellectual capital” who are able to provide the intelligent solutions not offered by the conventional reinsurer.
These solutions are invariably given for complex insurance problems. These are problems that a traditional reinsurance carrier is unlikely to consider offering because they do not fit into neat categories either by class, period or exposure. Rather than “winner takes all”, finite risk contracts share experience. At Scandinavian Re we have written policies that cover nearly every class of business in an enormous variety of solutions, that fit the needs of our clients. Finite risk at its best is simple, transparent and effective. At its worst it is over-expensive and over-complicated, perhaps even deliberately sometimes.
A finite risk solution will always allow the reinsured to know precisely the economic parameters of the solution and therefore be able to make long term budgetary decisions. A good product takes out the vagaries of the single year traditional reinsurance contract. Pricing for the future, with and without losses, is known.
Finite risk is unfortunately perceived as expensive. This is not necessarily the case. Although it might be expensive to participate in one's own losses, instead of passing risk to the traditional market at a low guaranteed cost, the benefits of a finite risk contract should be available at a lower net cost. These upsides should also expressly include investment income returns. There have, unfortunately, been too many well-publicised instances where insureds have paid too much only to find that later their contracts need to be unwound. However, these situations have usually occurred in the absence of competition and the fault can be laid at the door of those underwriters insisting on having exclusive relationships, often without the involvement of a broker.
What type of products are available?
The best way to describe the products is to give examples of some of the solutions that we have provided.
Scandinavian Re is a Bermuda based, A+ rated company that has underwritten business from five continents. The largest part of our portfolio of business has come from the United States and London.
In the London market Scandinavian Re has written the following products, among others:
• Catastrophe Combination Cover which provides Lloyd's syndicates with both catastrophe cover and helps to mitigate Lloyd's Dollar Trust Fund problems.
• IBNR Enhancement Contracts. Multi-year aggregate excess of loss covers that migrate the burden of IBNR reserving and claims development to Scandinavian Re. These alleviate the reinsured of adverse development at a known cost, and give the reinsured the benefit of returns for better than expected results.
• Multi-year excess of loss contracts that allow syndicates to double their premium income, through their dedicated corporate capital vehicles. This is an example of a simple contract that has often been needlessly over-complicated by other markets to push up the price.
• Aggregate excess of loss result stabilisation covers. These prospective contracts help to keep the reinsured within certain loss ratio parameters. They do so by using the experience account to help pay for claims, but in a way which is both cash and capital efficient.
Other intelligent solutions that have been provided in the United States are:
• Discounted Guaranteed Cost Quota Share Covers. These allow US carriers to offer their large insureds a fixed premium for first dollar coverage on their workers' compensation account. The carriers then cede both premiums and losses to Scandinavian Re as we can discount reserves, thus providing surplus relief.
• Catastrophe Excess of Loss Contracts helps the insured to smooth the spikes of large losses over time. This contract is a multi-year transaction with additional premium triggers that allows the spreading of losses from one year over the period, in order to provide stability and catastrophe protection.
• Adverse Development Covers allow the insured a degree of certainty that their estimated loss reserves will satisfy their paid loss requirements. This cover will protect the company from any excessive losses while also providing a profit commission if results are favourable.
• Transformation Contracts grant insurance companies access to underwrite capital market transactions. Normally they have taken the form of weather derivatives that are being placed into the insurance market. We will act as the front to allow the two entities to perform the transaction.
• Finally, the most successful product in the US is the Whole Account Aggregate Stop Loss. This contract provides multi-line and multi-year coverage for an insurer's loss ratio.
Who underwrites finite risk?
More and more companies. There has been significant growth in finite risk since the late 1980s when Scandinavian Re was founded. Within the Bermudian market, which has the largest concentration of finite risk insurers, there are at least 10 companies that specialise in finite protections. These include Accord Re, Commercial Risk, Centre Solutions, Enterprise Re, European International, Inter-Ocean Re, Richmond Insurance, Stockton Re and Western General.
Nearly every reinsurer of size now employs someone to deal with finite risk, or a department to get involved in it. Swiss Re has been involved since the late 1980s and Munich Re has been involved for quite a long time, though more quietly. Hannover Re and Cologne Re both set up specialist companies offshore to help them to underwrite more efficiently. However, it is still the specialist finite risk companies that seem to have the enterprise for the most cutting edge solutions.
The flexible alternative risk approach
We have learned over the past 10 years that flexibility in approach is one of the most important factors behind successful deals. When a client comes to us with an issue, they are looking for ideas and solutions. By having a small, expert staff we are able to provide swift responses that directly solve the problems. At Scandinavian Re we have 11 staff, and there will be four or five involved in every transaction. As Jens Juul, president of Scandinavian Re, said recently: “What brokers love about us is that when they want to sit down and discuss a transaction, they essentially get the whole company in one room.” Clients are not looking for hard and fast products that are repeated time and again, they are looking for solutions that are tailor made for their own individual needs. We listen, understand their needs, and offer total flexibility of ideas to work together to provide the right solution.
How will finite risk develop?
A phrase that is banded around lightly is “capital efficiency”. We believe that in the finite risk market we are taking insurance risk to the boundaries of capital efficiency. It is not efficient to pay too much too soon. We explicitly use the time value of money to help pay for losses or returns of premium. We create multiple-year contracts to allow clients to budget long-term. We use group capital synergies, within ABB, to help extraordinary problems and we take risk.
There is much talk about capital market intervention into insurance. This intervention is considered by most to be inferior to capital provided by traditional and finite reinsurance. It is expensive, short-term and unproven. Relationships do not exist that will ensure that capital is still supplied after capital markets suffer a loss. In all likelihood they will simply move on to their next fad. The traditional market has a proven track record of being there after a loss, with finite risk we simply try to improve on that.
Finite risk is a specialist area that should be seen as inexpensive use of capital, to provide economic stabilisation over the long term. It should provide flexible solutions to individual unique needs. Unfortunately, it is often viewed as expensive and overcomplicated. It should never be this. It really does provide solutions that are practical. It shares results with cedants to provide stable, consistent results and growth for both parties over time. These solutions are best provided by companies that specialise in the field, intelligent capital creating intelligent solutions.
Henry Withinshaw is a vice president and runs Scandinavian Re's representative office in London. He has 10 years' experience in the London market and has been with the ABB Group since 1991. Tel: + 44 (0) 171 264 0701.
Stephen Young is an assistant underwriter for Scandinavian Re in Bermuda and joined the company in 1996. Tel: 441 295 2743.