Achim Bauer believes the term “alternative risk transfer” is of little relevance to today's market. Risk managers, insurers and reinsurers need to look beyond the terminology and the packaging to see the real value of the product and service being offered.
“Alternative risk transfer” is yesterday's news. The word alternative assumes a world in which there is risk transfer - insurance and reinsurance - and then there are other, alternative, ways of doing things. This is simply no longer the case. The solutions that are being developed by those who have expertise in financial engineering and reinsurance can no longer be considered an alternative for organisations in the insurance markets. For those companies that wish to remain competitive, they are a necessity.
More than this, the words “alternative risk transfer” have been used so frequently, and applied to so many different products and services, that they have ceased to have any useful meaning. At its worst, ART is used as an excuse for some companies to present old products in new packages. Applying the term ART to the development of a captive, a finite risk contract, a long-term insurance contract doesn't add much value to the product being sold or to the value of the term itself. Risk managers, insurers and reinsurers need to look beyond the terminology and the packaging to see the real value of the product and service being offered.
On the other hand, companies which understand the power and potential of solutions (“ART” or not) that use the full range of capabilities available in the insurance and financial markets will truly be able to capture unique value. At Swiss Re New Markets (SRNM), we realise that we must approach each client with a blank sheet of paper. Taking a suitcase full of fully developed products to display is no longer a viable way to do business. Trying to apply a formula to a company that is in a unique strategic position will often be like trying to fit a square peg into a round hole. For us, it is more attractive to simply approach each company as a carpenter approaches each new job - with the ability to listen to and understand clients' needs, a bag of tools, years of experience, and some imagination.
When SRNM visits an insurance industry client, we do not go as a company looking to sell reinsurance. We approach insurance companies with a banker's focus: the client is a unique organisation in a particular strategic position, with particular needs and particular opportunities. We will look at the company from an outside-in perspective, and applying an analytical eye to the shape of the business, the company's strategy, and its strategic fit with respect to its competition and the industry in which it is operating. Having done this, we are then in a position to add some value to the way that the company manages its risk and capital base.
In our experience, many insurers have three things in common:
• The ceo often does not talk to the cfo about how the strategy is to be supported by the company's capital management
• The cfo doesn't tend to talk to the risk manager about how the company is financed and how that fits in with the way its risks are managed, and
• The reinsurance manager has his own fiefdom, and is often not brought into discussions with the ceo or the cfo regarding the strategy or financial management of the company.
SRNM sees these three points as providing the greatest potential for adding value to the client. Often these companies are reinsurance customers of Swiss Re, so we already have a strong relationship with them. Our goal is now to develop a dialogue with the company that involves each of these three parties, and to build upon our existing relationship by providing truly unique capital management and advisory services to these companies. By combining our depth of knowledge of insurance industry strategy, insurance company capital management skills, risk management, and the ability to lend the strength of our own balance sheet, we know that we can develop unique solutions that can add significant competitive advantage to our customer's financing.For firms in the insurance industry, the ability to manage capital and to maintain strength in the eyes of regulators and ratings agencies is often the key to growth. Growing through merger and acquisition can be extremely stressful for a firm's balance sheet, and the rating agencies and regulators will keep a watchful eye on ambitious organisations. Companies in all sectors of the insurance industry have seen this tension, from Netherland's Aegon, Australia's AMP, Italy's Generali through to Switzerland's Zurich Financial Services Group and the UK's composite insurers. These firms have been growing aggressively, but it is management's responsibility to ensure that the strain put on the balance sheet through leverage does not reflect on the view that the rating agencies and regulators take towards them.
We have many examples of this problem, of insurance companies reshaping their business, either through divestiture of non-core assets and the build up of core competencies. It is always a difficult balancing act, managing the tension between policyholders' interests and those of the shareholders. In addition you find an increasing number of companies with general capital limitations due to their mutual status. The firms have growth ambitions, yet could not become aggressively leveraged because this would deteriorate its ratings and expose it to leverage risk or because of regulatory constraints. In addition the firms need to bolster the capital base without taking on excessive amounts of debt.
In those cases, SRNM became involved by being a backing partner in the merger and acquisition, capital sourcing or capital restructuring activities. The range of solutions provided spanned over an efficient combination of embedded value financing, stop loss structures, loss portfolio transfers with adverse development covers and contingent capital. Cfos are increasingly interested in using alternative forms of capital such as contingent capital. In some of the cases SRNM committed to purchasing a predetermined capital instrument within a certain time period given the occurrence of an event (a trigger) that would have an adverse impact on the firm's capital structure. The trigger is structured around the finance director's main worries. We structured a programme that allowed the finance director of the firm to rest at ease regarding the firm's capital structure while it is growing. This allows the client firm to get on with the business of growing efficiently by assuring management that it could expand without being concerned that the rating agencies would dampen its plans because of a fluctuation in, say, the company's embedded value.
Another example of the increased preparedness to use reinsurance as a very powerful corporate finance tool was a situation where the client decided to acquire a composite insurance company. The strategic rationale for the acquisition was to integrate the life business, and use the non-life personal lines product and customer platform to cross-sell life products. The problem was a significant industrial lines business and active reinsurance portfolio, which needed a significant capital allocation and represented a latent risk to the company's overall performance and had rating implications. SRNM designed an integrated solution combining a portfolio transfer with an adverse development cover. This solution allowed the company to free up a significant amount of capital which could then be redeployed it in its growth business or paid back to its shareholders. It took away a significant downside risk, had a favourable rating impact and ultimately reduced the company's ultimate cost of capital.
Increasingly, Swiss Re is lending the strength of its balance sheet to firms in the industry, because it understands the nature of the business, the nature of risk, and the needs of insurance company ceos, finance directors and risk managers.
Partnership not salesmanship
Once again, the key to a successful relationship in this modern world is to understand that we are not out to sell products or do one off deals. Our ambition is to use our global knowledge of the insurance industry, our financial engineering expertise and understanding of the nature of risk, our client relationships and our advisory abilities to enable deals that should be done to get done. We want to ensure that our clients are able to achieve their goals.Achim Bauer is a principal of Swiss Re New
Markets and the head of the firm's Insurance Marketing Unit. Mr Bauer started his career at Deutsche Bank where he spent 10 years in different corporate finance assignments in Germany and abroad. From 1992 - 1995, he worked for Crédit Lyonnais SA both in Frankfurt and Paris and was responsible for setting up banks project finance and a financial engineering unit in Germany. Before joining Swiss Re, he was responsible for the corporate finance business of insurance companies in Germany, Switzerland and Austria at the Chase Manhattan Bank, London.