Mark C. Brockmeier examines the future of alternative risk financing.
Alternative Risk Transfer, Alternative Risk Financing, call it what you will. Even now, ART/ARF is still poorly defined. As re/insurance professionals, we can't say what ART is exactly, but we can tell you what it isn't. ART is more than just a market. It's a way of doing business, taking a standard program with an exception, reinsurance with a twist, securitisation of parts of standard covers. And that makes it a challenge both for business and for IT professionals who need to administer that business.
Getting to grips with alternative risk takes a mastery of primary and reinsurance markets. But is it a type of insurance or reinsurance? It is neither, both, or either as a deal begins to take shape. The ART underwriter, actuary, claims professional and accounting director are all highly skilled – and, now, highly sought – and their employers compete for business differently from other more traditional channels of underwriting.
Theirs is not a commodity product, consequently the complex transactions that result from insuring a multinational, multiperil, industrial risk are best characterised as a complex framework which will serve the client's specific needs. At the Risk and Insurance Management Society's (RIMS) annual conference – a gathering of corporate risk managers from the Americas and further afield recently held in Atlanta, US – increasingly those needs are one-stop shopping for these complex covers. A single broker, or even the risk manager, relies on the bidding organisation to collaborate and consult with them on what should be the ultimate structure of the deal. A single deal may take several hours (for a single risk or event being insured) to several months (for complex marine, aviation or property covers) and hence these kinds of deals are not written in high volume.
Organisations which write ART deals tend to be subsidiaries or divisions of well-established companies (almost every insurer and reinsurer with over $500m in written premium does these types of transactions). These ART organisations also tend to be global, with offices (or at least underwriting capability) in the major captive and ART domiciles as well as the parent home office. Captive hotbeds such as the offshore islands surrounding the UK (Jersey, Guernsey, Isle of Man) and in the major ones in the Americas (Vermont, Caribbean domiciles) now have ART representative offices going after not only primary insurers' business but corporate risks, groups, pools and captives. ART centres of competence such as Dublin and Bermuda have become major collections of the world's leading financial services organisations and a very focused pool of talent with which to expand capacity or set up new operations.
Characteristics of ART deals
While the dollar value transactions of these deals can run into several millions for a multi-year agreement, because of the complexity of the transactions and specialised staff involved there is often a team of individuals working on a deal. Several combinations of core underwriters/actuaries are called on with other opportunities as well, and while the number of submissions may be significant, if perhaps a couple of dozen high dollar deals are consummated annually it is an excellent year. Indeed, Stockton Re gave this very structural model and one of the primary drivers as the reason for selling its finite risk business and employees to Overseas Partners Ltd.
As re/insurance markets become more global, more e-intensive, the promise has been for transactions to become less costly. And that is certainly true for consumer markets, which have highly standard and regulated products for homeowners and motor coverages. But what of alternative risk transactions? Some of them, such as multinational, industrial or marine coverage, often known as master programs, are mostly primary coverages – just lots of them in many countries.
Others have many participants, many layers, including various deductibles, retentions and loss corridors. In other words, they are more reinsurance-like in their structure. So what is an IT administrator to do when confronted with a $2m or $5m cover with either or both of these characteristics?
Nature of ART transactions
The successful and well-established business model of these organisations is of a highly specialised organisation, working on many times the number of submissions than it actually signs, and the deals that do get ink are highly complex and high value. Most companies have been quite successful in this market and with this type of business model. The real problem becomes one of data and deal capture. These organisations, characterised by primary-like risks with reinsurance-like layers and program design, often cannot organise what risks they are covering worldwide, real-time. And with the pressure to produce high value deals, there is a significant danger of overlining a particular company, peril, geography or risk across the global organisation and across the parent firm.
Currently, many companies rely on regional underwriting data feeding into a central database or ‘data warehouse' against which the diligent company manager will run monthly and quarterly extracts to analyse data. The modern world, however, with its global risk and exposures, will overline even the most diligent company which looks at its exposure retrospectively.
Right way to use capital
Nowadays, it is not enough for a company to wait months to ink terms of a deal and get it into the administration system, and simply wait for a claim to happen – or not. Innovative risk underwriting such as ART needs flexibility in its underwriting and almost immediate knowledge of the company portfolio. If a company can get its hands on real-time exposure data as the risks are being underwritten, it can then decide whether or not to make adjustments to the exposure limits. Perhaps this single deal is worth excepting a per-country peril limit. Or perhaps capacity unused in France can be shifted to Italy or Switzerland.
Companies not only need to be able to put their capital to work but put it to work efficiently; to take capacity from one market, one risk, one peril, one geography, and move it when the opportunity arises. In this way the ART writer can truly serve the needs of the market and become the engine for profit envisioned by the parent company.
Capital allocation engines
Software companies such as Computer Sciences Corporation (CSC) have built these competencies through having re/insurance people design their systems; not IT people trying to figure out insurance, but industry professionals giving real-world functions to the desktop. In these types of companies, applications run from a similar set of screens, from which a re/insurer can aggregate its data into a single database because the company uses one system, worldwide, real-time and can help companies organise their business from regional to global.
It's a corporate commitment of giant proportions, but one which has come given the consolidation of the reinsurance (and shortly the insurance) industry in which larger and larger organisations amass surpluses in the billions.
Those billions can be put to work, either overlining traditional business in disparate systems, or – with some investment from a global corporation in a global philosophy and system of managing data – profitably improving margins for the parent firm with a sophisticated IT partner. Companies like CSC have the strength, stability, experience and staying power to see a company through its changing business landscape, and to flexibly meet those needs with innovative business solutions.
In essence, companies have always put information technology as a cost centre or a way to reduce cost.
While this advantage still exists, companies should review their approach to systems solutions and look at them for competitive advantage. If your system can allocate capital, use it. If it cannot, find one that does.
Not responding to good data tools means lost business, lost opportunity, larger and more unexpected claims. The ART market should continue its focus on innovation, or if not soon recognised, at the ART market's own peril, it will be at the mercy of competitors which will leapfrog ahead. And a strategic view of IT systems just might be the vehicle which does it.The ART of what if?
Imagine a large industrial enterprise that wants a cover for key chemical production facilities worldwide. It includes such hazards as buildings, contents, inland marine, environmental and CGL. There are obviously several coverages at work insuring the physical operations of these facilities. If these companies are located in France, Spain, Mexico, US (coastal Texas) and the Philippines, several problems are apparent for the underwriting team.
They have three or more different geographies (the Americas, Europe, Asia Pacific), at least two of which are in active seismic zones (Latin America, Philippines) and at least one in a potential hurricane zone (Texas). These different exposures need to be quantified and priced, but that's not the issue. Corporations that write ART may not wish to take on more than, say, $100m in earthquake risk exposure in aggregate or $50m in any one geographic area.
Or maybe no more than $80m in environmental risk worldwide, or $10m in any one country, or $30m in any one region. Most of today's systems, in capturing a deal of this complexity, will be able to see the individual property and individual coverage being written but not in context of the entire program.
So the next risk which comes through the door with the same types of exposure may not exceed the per country cover limits, but, unknown to the corporation, may exceed the per-region limits or the per-peril limits. Some of these very issues are the same ones which affected property insurers with catastrophic windstorm in the North American hurricanes of 1989 and 1992, with catastrophic results. Is the same problem happening to the ART market?