Amidst unprecedented economic and business hardship in the last year, the need for risk management and mitigation has risen on the agendas of executives and risk managers.
Conventional insurance, which businesses commonly turn to for risk transfer, doesn’t always fully address a company’s risk management needs — especially in a hardening insurance market like the one we are currently going through. This phenomenon partially explains the rise of businesses looking to supplement traditional insurance programs with alternative solutions — as these businesses seek to plug gaps in their risk management strategy.
To fully understand the growth of alternative risk transfer (ART) solutions (which include parametric solutions, captives, and structured solutions) as a means of mitigating commercial risk, it is necessary to understand three specific drivers and challenges in the prevailing risk environment — all of which are important considerations for businesses as they seek greater resilience against external threats.
Enhancing nat cat cover
In Asia Pacific, insurance losses have increased not only due to the increasing prevalence of large-scale natural catastrophes but also due to the frequency of secondary peril events (which are higher frequency, low-to-medium severity loss events such as hailstorms, flash floods, landslides, drought and wildfires).
One solution that has proven to be very effective in complementing traditional natural catastrophe insurance and filling the gaps of conventional programs is parametric insurance. Simply, parametric insurance is based on a pre-agreed event occurring and a pre-agreed payout.
It relies on a measurement of an event or index – such as temperature, wind speed, or precipitation – and unlike traditional indemnity insurance, it is independent from a client’s underlying asset. The formulaic payout means customers benefit from transparency and speed of the claims process. How a parametric solution is structured, however, is central to how it works in the real world.
For example, one of our clients in the manufacturing industry experienced significant business interruption losses as a result of an earthquake in Fukushima in February this year.
While the client had traditional earthquake insurance, it was their complementary parametric earthquake cover that enabled them to receive payment three days following confirmation of the magnitude of the earthquake by the Japan Meteorological Agency (JMA). The client was able to use the payment to cover immediate expenses, enabling them to get back to business quicker. Generally classified as pure financial losses, these would otherwise not have been covered by a conventional insurance policy.
Planning in a hardening market
Natural catastrophes aside, ART also fills a need in the current hardening insurance market environment — where risk managers are facing increased volatility and uncertainty for capacity and price.
Even if their insurance programs have not been impacted by large losses, renewal terms are becoming more unpredictable, making long-term planning and budgeting increasingly difficult.
The ART market offers a range of options to navigate this uncertainty, be it multi-line solutions, providing longer term coverage of three to five years, or a combination of both. Such multi-year, multi-line (MYML) insurance packages are an efficient way to give risk managers greater certainty of price and capacity in volatile market.
With less budget available and rising insurance premiums, an increasing number of risk managers are re-assessing their retention strategies. Captives, which are a proven and effective instrument to retain more risk in-house, are therefore becoming more popular as part of these hard market-induced reassessments. New captives are being formed and there is an increased utilisation of dormant captives.
Instead of transferring all risks to an insurer, a captive allows a business to retain some of their exposures in-house and thereby allows the corporation to keep underwriting profits and investment gains within the company.
Furthermore, for emerging risks such as supply chain risk, non-physical damage business interruption and cyber risk, which are each difficult to cover through traditional insurance, captives can work as a funding vehicle to pool and retain risk in these areas, without exposing the individual business units. This is because while the captive provides cover and protects the individual business units of the corporation, it retains most of the risk on a corporate level.
With the operating landscape for businesses evolving and the associated risks growing ever more complex as a result of climate change, cyber threats, and regulatory developments, to name a few, risk management is becoming more challenging for corporations.
The limitations of the traditional insurance market and the price volatility that accompanies it are only exacerbating this challenge. As such, to maximise a company’s ability to future-proof its business, it is necessary to explore innovative risk solutions that are available to plug gaps and complement traditional insurance programs, thereby enhancing business resilience in the long term.
This article was written by Jonathan Rake, CEO, APAC, Swiss Re Corporate Solutions. Rake is based in Singapore.
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