Hard insurance market promotes alternative risk transfer solutions

Tough insurance market conditions combined with a challenging economy are driving businesses to explore alternative risk transfer (ART) solutions such as parametric insurance.
Insurers have been significantly increasing premium in many risk areas and tightening terms and conditions at renewal to adjust rates to claims costs and improve profitability. Some businesses may perceive the quotes they receive as unfair and not reflective of the individual company’s risk profile. Others may struggle to attain the extent of coverage they are seeking.

These companies may therefore want to explore alternative risk transfer solutions, particularly if they are facing cash-flow challenges in a post-pandemic economy and are keen to reduce costs. In the current insurance climate, even companies with strong risk management principles and processes face increasing insurance costs. This is often driven by external factors well outside of their control such as global warming, a rising cyber threat, a higher incidence of natural catastrophes, or even COVID-19.

A few years ago, a company with a good risk profile would have a rather benign renewal, but the same company may now face premium increases without a change in its risk profile or in its claims’ history.

The current climate is even sometimes prompting companies to question the need to buy insurance and to consider keeping more risk on their own balance sheet. There is certainly an interest in taking more control of the insurance programme. This is prompting businesses to inquire about non-traditional insurance solutions such as captives, cell captives or parametric insurance.

Types of ART solutions

A ‘captive’ insurance company is an organisation that is established to predominantly insure or reinsure the risks of its parent, or organisations affiliated with its parent(s). The advantages of such a structure can include the possibility to better tailor coverage to the company’s needs, reduce operating costs, enable greater control over claims and increased coverage and capacity.

Another ART option is a protected cell structure where a single legal entity consists of a core linked to several cells that have separate assets and liabilities. Each individual cell is often expected to keep collateralized underwriting risk within the cell, ring-fencing and insulating these from the other cell companies. The core manages the majority of the governance and regulatory requirements, potentially reducing the regulatory burden. This structure can also be less expensive to administer and offer tax benefits compared to a company with multiple subsidiaries.

While there are many different ART solutions on the market today, this space is continually evolving. An area that is particularly dynamic is parametric solutions which are tailored to the specific needs of a company.

Parametric or index-based insurance solutions cover the probability of a predefined trigger event such as a flood or an earthquake as opposed to indemnifying actual loss incurred. In case of a flood, the parameter or index will be the level of precipitation or the water level of a river that would trigger the insurance payment. The underlying trigger data needs to be independently verifiable, such as the cyclone strength as reported by the Australian Bureau of Meteorology, for example.

If the data from the selected independent third-party agent shows that the pre-agreed level that triggers the insurance has been reached the payment is automatically approved. It doesn’t require a loss adjuster to calculate the damage. Parametric insurance claims are therefore paid out quicker and there is little room for disputes due to the higher level of transparency and the underlying data.

While parametric insurance can be a great opportunity to plug protection gaps it is not designed to be a standalone insurance policy. Instead, it needs to fit in the wider protection plan of the business.

When exploring ART solutions may make sense

  • The company struggles to find appropriate cover and faces restricted coverage, premium increases, etc.

  • Comprehensive data on risk exposure is available.

  • Official data is available for the specific risk type (rainfall, tremor, wind speed etc.).

Examples of ART solutions

Parametric cover can reduce insurance costs in a hard market. Lockton’s Alternative Risk Transfer and Captives leader in New Zealand has, for example, been previously involved in a solution for the food and drinks industry where a company was facing an expensive hail policy at renewal with decreasing limits and restricted coverage. Hail events can hit the fruit supply severely and consequently make them very expensive, causing costs to spiral for the business.

A dual trigger policy for the company was secured, covering a variety of weather-related events such as storms and frost. To trigger a claim there had to be a weather event and the production yield had to be below a pre-determined level. This policy has recently successfully paid out a claim.

In another case, a Lockton expert was involved in creating an alternative protection against tropical cyclones and earthquakes for vulnerable communities in Pacific Islands countries through a combination of a parametric and a captive solutions.

In a first-ever move the Pacific catastrophic risk insurance company, a captive, was established in the Pacific region to cover earthquake, tsunami and tropical cyclone risks. Further, countries were able to contract a parametric policy and select the level of coverage protecting them against these natural catastrophe events. Following an event of a certain magnitude and location, the model (based on 10,000 years of natural catastrophe disasters) can immediately trigger a payment to the country (within 7 days).

In 2018, category five cyclone Gita hit the kingdom of Tonga triggering a payment of $3.5m. The funds enabled the Kingdom to purchase and distribute essential supplies such as water, food, materials for shelter to outer islands or harder to reach areas.

Parametric insurance can be designed for a variety of triggers such as market indices, power outages and footfall.

For further information, please contact:

Jessica Schade , Head of Captive / Alternative Risk Transfer Lockton New Zealand

M: +64 21 909 203

E: Jessica.Schade@lockton.com