Sailors understand that ocean conditions can worsen quickly, and adaptation is necessary to survive in a storm. Insurance buyers face an equally stormy situation in the current hard insurance market. Alternative risk transfer (ART) provides risk managers with the flexibility needed to ride out tempests in the insurance market. And just like successful sailors adapt to the conditions of the sea, risk managers who had the foresight to act before the hard market and adopt ART, have fared better than most.
The ability to consider the value of an insurance purchase, within a portfolio of programs, is the foundation of a successful risk transfer strategy.
We are currently navigating a hard insurance market. While parts of the insurance market are showing signs of stabilizing, we expect the hard market will continue into 2022. Additionally, there is a great deal of uncertainty between possible new variants of COVID-19 and a war in Europe impacting global health and the world economy.
In this paper, we reflect on historic and future uses of ART from a global view. We structure our analysis into:
In the hard market there is a preference for simplicity among ART insurers, and buyers have had to adjust.
Structured solutions are becoming more common wherever traditional markets are charging rates-on-line (premium/limit) of 40%+ for a layer of insurance. We see increased interest and use of fronting with structured reinsurance options in place behind captives.
For hard to insure risk classes, we were able to bridge between increased retention and higher traditional market attachment points. With solid analytics behind them, and a clear definition by buyers of their risk tolerance and appetite, these solutions have proven important as the hard market has disrupted pricing and allocations.
Savvy users have realized their flexibility where parametric capacity can be creatively applied to address risks such as pandemics.
Meanwhile, parametric solutions won the popularity contest in 2020 and 2021 for several reasons:
Moreover, parametric solutions were priced competitively. Also a significant increase in venture capital (VC) funding helped draw attention to these solutions1.
Parametric solutions often complement property placements by filling-in for deductibles, topping up limits and covering for uninsured risks (such as non-damage business interruption risk).
Savvy users have realized their flexibility where parametric capacity can be creatively applied to address risks such as pandemics, but also to create community goodwill. After all, when a company is impacted by a natural catastrophe, their employees and local community are too – think of the “S” in environmental, social and governance (ESG).
Clients who established multiyear integrated programs, a portfolio solution, before 2019 were insulated from the subsequent market volatility and rate increases as these hit annual policies. Unfortunately, we are seeing capacity for these solutions diminish significantly as ART units are forced to adopt the same underwriting restrictions as traditional monoline underwriting standards, despite the embedded diversification and structural features that change the risk profile of a placement.
Finally, as 2021 ended, we saw increased activity in catastrophe bonds that cover windstorm and earthquake risk, such as the bonds issued by Alphabet, Prologis and NN Group. We are excited by the momentum and believe this could indicate a new trend of corporates exploring a new source of capacity for natural catastrophe (nat cat) risks.
We agree with McKinsey & Co. on the fact that as catastrophic events have become more frequent, and the economy more interconnected, the need for insurance has increased. Swiss Re is right that awareness of risks has risen among the C-suite during the COVID-19 pandemic. Companies are seeking more comprehensive and flexible protection, such as parametric covers and catastrophe bonds as they adapt to new ways of working.
The pandemic has indeed cemented positive paradigm shifts for insurance. For example, ESG issues are changing the way the insurance industry engages. We structure our discussion into three:
The impacts of climate change on weather and natural catastrophe risk are now beyond debate as evidenced by last year’s COP26 conference in Scotland. For companies thinking about the ways the changing climate might affect their business, the risks fall broadly into three types:
ART solutions play across the three. Parametric solutions are important for tackling physical risks, and structured solutions are key to help finance potential liability risks in a challenging insurance market.
In addition, ART solutions help support the adoption of green technologies and renewable energy. Examples include backstopping performance risk, which gives debt financers the comfort to back projects. For example, parametric solutions can cover lack of
Finally, we see a platform for expansion with resiliency financing, and resiliency bonds. Coupling finance with insurance will allow for financing of projects and initiatives that consider both traditional investment risk, as well as the climate considerations and risks.
Demand for parametric solutions will continue to rise as the hard market will continue through the second quarter. Where parametric solutions cover nat cat risk, we believe the price discovery will become more standardized (see digitization section later in the article).
Brokers will need to:
Our clients continue to use parametric solutions to fill-in and cover nat cat gaps in traditional property damage and business interruption placements.
Parametric solutions are well positioned to address supply chain concerns.
Furthermore, demand will increase to support disaster risk financing and ESG initiatives such as those for the Mesoamerican Reef. A good example of this is Belize’s recent blue bond, which was the first sovereign debt insurance that included a “catastrophe wrapper”.
As buyers’ understanding deepens, the positive attributes of parametric solutions will lead buyers to finance business risk (lower cost and/or insure against loss of revenue) that occur beyond nat cat and physical risk events. These solutions ensure that financing is available for a corporate’s contingency plans, as well as the increased costs that come from operating due to non-physical damage events.
For many corporates, there is now a focus on keeping employees safe and operational, as well as protecting physical assets. With an increased awareness of risk, and the need for risk management solutions, we encourage the C-suite to consider adding additional budgets for the purchase of parametric solutions to ensure that there is sufficient working capital for contingency efforts in events that have clear triggers. Parametric solutions will not only complement property damage and business interruption (PDBI) insurance, but it is a strategy to address non-damage business interruption scenarios.
We expect risk financing in the form of structured solutions will increasingly become a favorite option as the hard market trends continue in 2022. We strongly believe that multi-line, multi-year structured programs will be the result of the mix of constrained insurance market capacity with a continued interest among insurance buyers of portfolio solutions.
A structured multi-line program should be viewed differently than a pure integrated program. One of the advantages of the structured multi-line program is that a large portion of the limit is prefunded, which reduces the perceived cost of capital for insurers looking to support the solution. With more premium in the structure, a wider range of clients will be able to access new carriers and capacity. Finally, the solution is a solid alternative to a captive, or with a captive in place, can be used as reinsurance.
We are seeing clients accessing ART solutions as cover for cyber and directors and officers (D&O) insurance. We believe more companies will look to self-insure these two lines of insurance as market pricing becomes unpalatable, yet contractual commitments demand coverage. Other distressed lines of insurance such as credit may see similar trends. Solutions will include risk financing and working with fronting partners to arrange viable options.
Careful structuring is required to attain regulatory approval for D&O solutions. However, we are positive about the potential. For example, recent market entrants that provide special purpose acquisition companies (SPACs) with D&O cover are an exciting example of innovation.
There has been a reduction in the nominal amount of coverage in insurance programs among our large corporate clients, especially for risks such as cyber and natural catastrophes in property damage and business interruption insurance. The introduction of shared risk portfolios of diverse risks should become more common.
Consider applying the principles of a standard captive (shared by subsidiaries) to create a mutual captive that shares the risks of a panel of clients, sometimes referred to as a “captive of captives,” where clients share a secondary insurance capacity source. The mutual secondary source of capacity is only accessed once individual capacity is exceeded. The diversity of risk exposures reduces the likelihood that multiple panelists will need to access the secondary source in the same year, making this mutual structure attractive to reinsurers.
While the future is impossible to predict, we have identified the following themes that will be important to the growth and maturation of ART solutions:
Global broadband traffic rose by 51% in 2020 as telework, telemedicine, streaming and e-commerce boomed. The insurance industry has adopted a new, digitalized working model over the last two years.
Brokers will become advisors helping drive price discovery and optimization of cover.
We expect insurance transactions will become automated, and brokers will evolve by offering platforms that match insurance buyers with capacity providers. As a result, brokers will become advisors helping drive price discovery and optimization of cover.
In a marketplace that is built on analytics, risk evaluation and quantification, a portfolio approach will work best. This will influence program design. We strongly believe that this will drive clients to pursue portfolio solutions with multi-year, multi-line capacity. This, in turn, will require long-term relationships between clients and their insurers, which is an outcome from digitalization that excites us.
Furthermore, we look forward to digitization of data, which will enable a more dynamic model of buying parametric solutions.
McKinsey correctly points out that the average cost of smart sensors has fallen drastically in the last two decades, and is likely to continue to fall in the next five years potentially resulting in increased usage and more data that can both reduce losses and help with risk transfer on a parametric basis. An example of such an application is the water depth sensing technology used by U.K.-based flood insurer Floodflash to trigger the claims process.
We also see applications where data such as footfall, traffic data (both physical and online) and client owned data (such as machinery operating data) are used in ART solutions. Additionally, quantum sensing will likely have significant impact on asset monitoring and related insurance solutions in the future.
Parametric solutions are well positioned to address supply chain concerns. Insurers can use marine, aviation, rail or road traffic data to structure solutions to cover disruptions at key bottlenecks. Where these disruptions can be tied to industry activity indices, or economic indices, we see players such as OTT Risk introducing insurance capacity to fill a gap for risks that were previously uninsured or uninsurable.
Organizations face continued challenges in understanding, managing and protecting the combined value of their traditional and intangible assets. With the help of analytics and actuarial expertise, brokers can forecast intellectual property (IP) loss potential and measure the impact of insurance structures on that risk by using data from judgments in IP cases. With risk quantification at hand, we see relevant ART solutions in captive and portfolio solutions where risk financing and transfer can be introduced for corporate clients looking to actively manage risks associated with their intangible assets, which make up 90% of the S&P 500 market value.
As economic cycles change, and credit risk evolves (following the potential end to quantitative easing and a possible increase in interest rates), we anticipate a growth in the demand for smart credit insurance solutions, which will focus on business and economic risk. Solutions will need to be designed to drive balance sheet efficiencies allowing CFOs to take an important step to free up cash. These areas may include
Predicting the end of the hard insurance market is difficult. However, when carriers finally supply additional capacity prices will stabilize. Brokers that evaluate capacity and price options for clients in real time are invaluable especially in the context of a portfolio buying decision that aims to optimize the price of risk of that strategy.
The ability to consider the value of an insurance purchase, within a portfolio of programs, is the foundation of a successful risk transfer strategy. Therefore, we think that 2023 will be the time to reconsider portfolio solutions, and to lock-in long-term capacity and rebuild partnerships with insurers.
If capacity returns to the market, the formula for an optimal transfer of risk to insurance markets will change. We recognize the fatigue that comes from an annual purchasing cycle in a distressed environment.
As we already highlighted, digitization will mean that new capacity can enter the market through electronic platforms. We strongly encourage insurance buyers to prepare by having a solid quantification of their risks when they pursue capacity on these new electronic platforms.
The aim of this paper was to illustrate how ART strategies can help you prepare for your company’s next renewal, and help evolve your risk financing strategies for the next five to 10 years.
Often in the ART sector, innovation comes from addressing unique challenges. Sometimes the solutions we create become mainstream – parametric approaches are a good example of a niche solution finding broader use.
We certainly see opportunity. The advancements of the last few years will drive further change and innovation creating a new reality for corporate risk managers. And, as these new solutions emerge, those companies that have honed their skills in the recent storms, will be ready to take financial advantage of some calmer insurance waters.
1 Willis Towers Watson Insurtech Report Q4 2021
Willis Towers Watson hopes you found the general information provided in this publication informative and helpful. The information contained herein is not intended to constitute legal or other professional advice and should not be relied upon in lieu of consultation with your own legal advisors. In the event you would like more information regarding your insurance coverage, please do not hesitate to reach out to us. In North America, Willis Towers Watson offers insurance products through licensed entities, including Willis Towers Watson Northeast, Inc. (in the United States) and Willis Canada Inc. (in Canada).
