Julie Smith | Corporate Strategic Account Manager | Aon South Africa | mail me |
We live in a volatile world where geopolitical risks, economic inflation, natural disasters and an increasingly complex regulatory environment are applying pressures on all fronts, including the insurance sector.
Underwriting requirements are becoming stringent. P prospective clients are having to provide far more granular information about their portfolio of risks as well as risk mitigation measures. Reduced capacity and insurer appetite for certain classes of risks remain a real concern.
Renewals are much tougher than before
Businesses may be surprised to find that renewals are much tougher than before. Risks that were previously covered now either being uninsurable or attracting onerous terms, conditions and hefty deductibles.
Securing sufficient insurance capacity from local and global insurers continues to be challenging. Hardening insurance market conditions are the cause of reduced reinsurance capacity and appetite. This means that traditional insurance solutions are becoming unaffordable, or in some cases, the risk has become uninsurable.
The insurance market is, however, more amenable to businesses that take greater ownership of their risk mitigation by deploying proactive risk strategies. Risk sharing through increased deductibles can, in turn, be funded through alternative risk financing solutions. This is achieved by either incorporating a captive insurance solution or implementing an aggregate fund, or a combination of the two.
Captive insurance defined
Captive insurance solutions are valuable tools to navigate volatile market conditions in terms of risk financing. They help fill the widening gaps in coverage, especially in challenging risk markets such as cyber, property, terrorism, sabotage, and weather catastrophes.
A captive is effectively an insurance company set up by a business primarily to self-insure against specific risks. This allows the business to take financial control of its insurance allocations. If the business runs mature risk management programs alongside risk consulting solutions, it can consolidate its premiums. Instead of paying premiums to traditional insurers, the business can leverage them to build scale within a captive.
Adding captives to an organisation’s risk financing toolkit begins with assessing the total cost of risk. The next step is designing an optimal program that balances risk retention and risk transfer. This allows the business to take on a sizable increase in its risk retention level. The business ultimately reinsures its own risk. It can then partner with a risk financing provider to secure an insurance policy. This partnership helps the business lock down more favourable terms and deductibles.
Having a captive arrangement in place is an attractive advantage for the business in terms of risk retention levels. Actuaries can factor this into their assessments, alongside the organisation’s past claims history. Captive arrangements make the most sense when expected losses are lower than traditional premiums and deductibles. This is based on actuarial calculations, showing a financial benefit compared to traditional insurance.
Aggregate funds
An alternative to a captive solution is an aggregate fund. In this case, the business approaches the insurance sector to set up a contingency fund for non-insurable risks. The business invests in an aggregate excess. This excess puts money into a risk-financing house.
An example would be a big fleet company that has an aggregate excess plan with a stop loss attached to it:
- An aggregate excess is the overall retention fund for the client. In this example, the fleet operator has put a R10 million aggregate excess on a fleet of 1000 trucks. Considering the business’ claims history, they would be able to secure a better insurance premium by taking more of the risk on themselves.
- Within the aggregate excess there could be protection for the client by way of a stop loss where the insurers will agree to pay for any one loss over a specified limit. For example, within your R10 million aggregate excess, you may have an R500,000 stop loss agreement, which means the business will only ever pay for a single insured loss up to an R500,000 limit – anything above that would be carried by the insurer.
The aggregate fund still forms part of the contract with the insurer. Claims to the fund are treated like any other, duly assessed and documented by the insurer. A key benefit of an aggregate fund is the business’s ability to manage its claims better. Any money left in the aggregate fund can be transferred to the following year.
In conclusion
Insurers tend to be more amenable to businesses that proactively finance, retain and manage more risks themselves. As a result, businesses require sophisticated risk modeling solutions to support informed decision-making on risk financing alternatives. These alternatives include captives and aggregate funds, helping to optimise the total cost of risk.
Balancing financial analysis and risk engineering is a high-stakes and complex task. It is best undertaken with guidance from professional risk consultants. These consultants have the expertise to enable better decisions around alternative risk financing solutions.
Related FAQs: Alternative risk financing solutions
Q: What are some alternative risk financing solutions available for insurance needs?
A: Alternative risk financing solutions include options like parametric insurance, insurance linked securities and structured risk financing facilities that cater to specific business needs beyond traditional commercial insurance.
Q: How does alternative risk transfer differ from traditional risk transfer?
A: Alternative risk transfer provides non-traditional methods to manage risk, leveraging unique structures and sources of capital, while traditional risk transfer typically involves transferring risk through standard commercial insurance products.
Q: What role do brokers play in alternative risk finance?
A: Brokers are essential in alternative risk finance as they help identify tailored solutions, structure risk financing facilities and facilitate strong relationships between clients and providers of alternative risk transfer options.
Q: Can alternative risk finance strategies help mitigate volatility in business operations?
A: Yes, alternative risk finance strategies are designed to address volatility by providing tailored solutions that meet your specific risk management needs, which allow businesses to navigate a growing number of risk scenarios more effectively.
Q: What are risk financing facilities in the context of alternative risk finance?
A: Risk financing facilities are structured arrangements that provide businesses with the ability to finance their risks through non-traditional means, allowing for flexibility and creativity in addressing unique risk profiles.
Q: How can companies leverage alternative risk solutions for their insurance needs?
A: Companies can leverage alternative risk solutions by integrating them into their overall risk management strategy, thereby creating a broad range of options that align with their specific appetites for financing corporate risk.
Q: What types of insurance products fall under alternative risk transfer?
A: Insurance products under alternative risk transfer include parametric insurance, insurance linked securities and tailored insurance plans that are designed to respond to specific risk events and business needs without relying solely on traditional insurance mechanisms.
Q: What factors should businesses consider when implementing alternative risk finance solutions?
A: Businesses should consider factors such as their risk management needs, the volatility of their operating environment, the effectiveness of actuarial analytics and their overall risk finance strategies before implementing alternative risk finance solutions.
Q: How do insurance and reinsurance interact with alternative risk financing?
A: Insurance and reinsurance interact with alternative risk financing by providing a framework for risk transfer solutions that can include traditional and non-traditional elements, enhancing overall risk management capabilities for businesses.
