Alternative risk transfer for corporations
No. 2/1999
Few concepts in the world of insurance and risk management have been the subject of as much intense discussion as ART. As a follow-up to sigma 5/1996 and 5/1997, which provided an in-depth study of individual ART solutions for insurance companies, this study in the sigma series provides a broad overview of the ART solutions available for industrial and service companies. The latest publication presents the economic reasons, basic characteristics, most important types of ART as well as the future prospects for alternative risk solutions.
ART: an esoteric term
Most ART solutions are tailored to specific client problems. They usually offer multi-year and multi-line cover, thereby spreading risk over a period of time and within the policyholder's portfolio. Furthermore ART solutions that are based on capital market instruments involve a risk transfer to non-(re)insurers. Against such a backdrop ART solutions are set to come into their own as they increase the efficiency of the risk transfer, broaden the spectrum of insurable risks and tap into bigger insurance capacities via the capital market. They allow a company to dedicate its capital to its core business as they target solutions that are applicable across the company's entire risk spectrum.
The most important forms of ART
The spectrum of ART solutions has expanded rapidly over the last few decades, whereby the focus has been initially on captives, which allow companies to deal with high-frequency risks in a more cost-efficient way than through traditional industrial insurance. Alongside captives finite risk products are another well established type of ART. These are based primarily on spreading the risks for the individual policyholder over a period of time. The most important advantages from the client's standpoint are that risk costs are stabilised and - by limiting old claims - the corporate value may be increased, thereby making takeovers and mergers easier. Integrated multi-year/multi-line products are examples of the more recent types of ART. The advantages for the client comprise the following: bundling together negatively correlated and uncorrelated risks frees up a company's own diversification potential, thereby allowing it to increase its deductible. Attempts to transfer insurance risk directly to capital market investors have received special attention over the past few years, particularly at the reinsurance level. This can be through the securitisation of risk in the form of insurance bonds or via derivatives transactions. In this way the policyholder obtains additional capacity without running any credit risk (particularly for catastrophe losses), while investors are able to further diversify their investment portfolios.
ART for corporates: a market with a premium volume of around USD 30 billion
Because the boundaries between traditional and alternative risk financing tend to be blurred, it is extremely difficult to make quantitative statements about the market volume of ART products. Estimates set premium volume at round USD 30 billion, with captives accounting for more than two thirds and finite risk solutions for just under a fifth. Integrated multi-year/multi-line products, multi-trigger cover, contingent capital as well as insurance bonds and derivatives are still insignificant in terms of volume.
Outlook
The potential for an acceleration in the growth of ART solutions is considerable. The ongoing globalisation, deregulation of additional industrial and service sectors, the growing emphasis on shareholder value and the rapid change in the risk landscape are increasing the appeal of alternative forms of risk management.
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