ART and Self Retention Remain Relevant as Insurance Market Appetites Wane in Wake of Spate of NatCats & Capacity Reduction

25th September 2013

By: Creamer Media Reporter

  

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Changes in the insurance industry have sparked renewed interest in Alternative Risk Transfer (ART), a method of protecting business assets by making use of non-traditional methods available in the insurance market.  Furthermore, there is a growing need to develop real Alternative Risk Transfer (ART) solutions for large corporates, not only in terms of the changed accounting and tax environment, but the volatility of the insurance market following a spate of recent natural catastrophes that have substantially altered the approach to risk acceptance by conventional insurers.

This is according to Rob Gollnitz, Head of Risk Consulting at Aon South Africa.  “ART is a sensible alternative for clients with a mature risk strategy, a long-term, top-management commitment to loss prevention, a willingness to share the risk and a serious focus on loss control.  Formalised risk retentions by corporates as a method of insurance risk management to reduce reliance on conventional insurers, insure uninsurable or difficult to insure risks, is still highly relevant in global markets, also evidenced in Aon’s recently released 2013 Global Risk Management Survey,” he says. 

Companies of all sizes can have a challenging time finding and affording traditional insurance policies to cover their risks and assets and in some instances, certain risks simply are not insurable. Premiums are hardening as reinsurers feel the bite of a spate of natural catastrophes and in some specialised classes of  insurance such as Medical Malpractice, resulting in huge losses around the world.  Some companies simply have risks that are difficult or impossible to cover effectively through traditional insurance routes. Without an effective ART strategy, these companies would be vulnerable to crippling losses.  For these, self-retention of insurable risk via various vehicles, as a main vehicle of alternative risk transfer can be a solution. 

“In the context of ART however, this relates to the payment of premium derived by using actuarial and other risk information so that the amount set aside via self-retention, similar to the insurance premium, is enough to cover future uncertain losses with the added benefit of additional cover from the leverage through the self-retention vehicle,” explains Rob.

Aon’s 2013 Global Risk Management Survey shows that organisations in all industry groups and geographies continue to use captive insurance companies as a cost-effective and strategic risk management tool. About 15 per cent of respondents report having an active captive or Protected Cell Company. Within a captive, property and general liability are the most often underwritten lines of coverage. In emerging markets, such as Latin America and certain parts of Asia Pacific, there is growing interest in captives.

By region, the number of organisations in the Middle East and Africa with a captive or protected cell company comes in significantly ahead of any other region at 33%, which is followed by North America at 22%, Asia Pacific at 17%, Europe at 14% and Latin America at 12%.

Various types of self-insurance programmes have existed for many years, providing a key element of risk management.  Since 2005 when various accounting changes with regard to captives where legislated, it came with some measure of complexity around its implications, although it did create certainty and consistency in interpretation of risk transfer structures for accountancy purposes.  The accounting changes essentially brought about significant reporting implications for corporates with large risk finance programmes, in that an investment contract is now recognised as a financial asset on the balance sheet, whereas an insurance contract is treated as an expense in the income statement. However none of this detracts from the fact that self-insurance in the context of ART is still a totally relevant and beneficial means of risk transfer for larger corporates in particular,” says Rob.

“The fundamental benefits to corporates of self-insurance structures include lower insurance premiums in lieu of improved claims history, encouraging risk management of insurance exposures, the creation of additional insurance capacity and potential financial efficiencies.  ART remains as relevant as ever today, and provides the benefits of greater efficiency leading to reduced cost of risk,” adds Rob.

From a regional perspective, Aon believes that there is room for growth in self-retention vehicles in Latin America over the next five years, with longer-term potential for Eastern Europe, Middle East, Africa and Asia Pacific. At present, market liberalisation issues and local regulatory restrictions can still be barriers to entry for potential captive owners in the above regions. However, as the risk management needs of regional industries are increasing in scope and complexity, local carriers will struggle to meet future risk financing demands.

“As the economy improves, increased mergers and acquisitions activity resulting in consolidation strategies being required for multiple captive owners is likely to be a prominent feature.  For organisations that are planning to create a new captive or other self-retention vehicle, industry sector analysis reveals where the main interest is likely to be in the next three years. The top four sectors are: pharmaceuticals and biotechnology at 20 per cent, banks at 19 per cent, utilities at 18 per cent, and hotels and hospitality at 17 per cent. In the pharmaceutical industry, interest in captives is primarily driven by inadequate capacity for product liability and medical malpractice, while the utilities sector is experiencing a hardening property market. 

“Captives are being used to underwrite areas where there is little or no commercial appetite for the risk and for absorbing high self-insured retentions. Financial institutions are interested in increasing income-producing opportunities by expanding their captive programs to customer risks. Finally, the hotel and hospitality industry is finding that captives are helping on a number of fronts. They help support terrorism-related insurance programs in the U.S., and given the size of their employee base, are commonly used to write workers compensation and general liability risks. For global programs, the captive provides a cost-effective tool to bring consistency and coordination to global program terms and conditions,” adds Rob.

Key risks underwritten

Similar to Aon’s 2011 survey, general liability and property are the most often underwritten lines of coverage within a captive or self-retention vehicle, both at 41 per cent. Other popular lines include motor vehicle liability at 33 per cent, employers liability / workers compensation at 32 per cent, products liability at 23 per cent and professional indemnity / errors & omissions at 19 per cent.

In the 2013 survey, respondents indicate increased interest in underwriting the following risks over the next five years: cyber liability/network liability: 7 per cent, employee benefits (excluding health/medical and life): 6 per cent, directors & officers liability: 6 per cent, credit/trade credit: 5 per cent, employment practices liability: 5 per cent.

“Finally, the benefits of using a self-retention vehicle as part of a coordinated global program include pre-funding for losses, access to additional capacity in the reinsurance markets, more control over claims handling, increased leverage to negotiate best and consistent terms and conditions, and reducing payaway premium that might otherwise go to the commercial market. It is also worth noting that as regulatory and legislative changes are becoming more burdensome to companies, self-retention usage will increase as a means to regulate corporate deductibles and retentions in a controlled audited environment,” conclude

Edited by Creamer Media Reporter

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