NEXT GEN RISK FINANCE: BECOMING THE UNDERWRITER OF CHOICE

“We are now able to connect risk information with specific company performance information to inform and guide future strategy.”

Albert Einstein once said: “We cannot solve our problems with the same thinking we used when we created them.”

As traditional insurance markets continue to firm and harden with rising prices and reductions in available coverage, many companies have turned to their existing captive insurance companies, or they have created new ones. Indeed, the concept of captive insurance is hardly novel or new. But now, more than ever, data-driven strategies are being utilized to justify the use of such structures or to enhance already existing ones.

For some time, enterprise risk management (ERM) has sought to more effectively use risk data to improve the predictability of hazard risk appetite and risk assumption. Market price and capacity constrictions in the global insurance and risk transfer marketplaces have encouraged large, publicly and privately-traded companies which also successfully operate captive insurance companies, to reevaluate their fundamental philosophies regarding risk and insurance.

Questions

On an initial level, the central questions these companies are asking include, but are not limited to:

• Is the risk transfer market correctly analyzing and underwriting my specific risks, or is it simply “lumping” me in with others?
• Is the open insurance market fairly and efficiently pricing my risks, or are my insurance costs skewed by the performance of others?
• Does my data suggest that I could underwrite and price my risks more effectively and economically than the open insurance market may give me credit for?
• What analytics or metrics should I be using to better understand my risk appetite and total cost of risk (TCOR) philosophy and risk-bearing capacity?
• Is a multi-line portfolio approach to risk finance potentially a more effective way to manage risk volatility and provide me with more predictable cost projections than other, more conventional approaches?

Next gen risk finance is a concept that helps to answer these fundamental questions. It is a rapidly evolving ERM framework that encourages organizations of size to utilize emerging analytic finance, treasury, and risk portfolio management techniques to leverage an organization’s risk underwriting awareness and capacity, thus allowing the organization to become its own “underwriter of choice”.

Figure 1: Next gen risk finance process—keys to success

Tenets

Key tenets of next gen risk finance include:

• Enhancing the ability to “see” risk opportunities and advantages in the traditionally collected risk finance and risk management data that could not be seen five years ago. With next gen risk finance, we are now able to connect risk information with specific company performance information to inform and guide future strategy and financial performance. In effect, the firm could use its captive to opportunistically become the “underwriter of choice”.
• Recognizing that, while insurance coverages are generally organized and placed individually, there is advantage in reorganizing and analyzing coverages in a more robust risk portfolio. Utilizing a “risk portfolio” approach allows organizations to leverage their understanding of TCOR into managing “bounded” risk volatility. Risk volatility can now be used to establish risk retention and risk transfer.
• Using risk portfolios to “house” basket aggregate or more inclusive lines of coverage across all hazard, financial and operational risk categories. In effect, the risk portfolio becomes the financial underpinning for enterprise-wide risk finance strategy and initiatives.

By employing new analytic tools to establish a corporation’s conceptual efficient risk frontier and measure it against risk mitigation strategies, next gen risk finance provides senior management with an enhanced view of a company’s risk profile, risk appetite philosophy and risk retention potential. These analytic tools now allow us to address additional, more probative questions about a company’s risk profile:

• Can we now “underwrite” the company’s risk and price risk transfer “organically”, irrespective of market perception or historical risk pricing? By doing so, we should be able to better understand the value of a carrier’s “portfolio underwriting” impact on price and program design.
• Can we now “underwrite” the company’s risk portfolio to determine the effective trading price with the market accounting for retention and layering strategy? Can we establish the economic “strike price” that demarks the point where the firm would be prepared to “purchase the risk” for themselves versus transferring premium to the market?
• Can we take advantage of new analytics to place our company in the best position to “assume” the best risk layer positions at effective prices across varying lines of coverage? Can we establish premium strike prices by layer?
• Are we in a position to utilize alternative risk transfer opportunities (eg, creating or using an existing captive insurance arrangement) to devise a more bespoke and robust approach to managing, controlling and financing risk, and are we prepared to deploy capital to support such an approach?
• Armed with the analytics, can we effectively educate senior management on the reasons why supporting the use of such alternative risk transfer opportunities may be viable and beneficial?

Using a recalibrated and priced risk portfolio, companies can initiate a new and different dialogue with the market where they can signal their price intentions across an entire portfolio. Where the market meets or beats the strike price, the company trades. Where the market does not meet the strike price, the company retains the risk (eg, via its captive insurance company) or on its own balance sheet.

Next gen risk finance also enables a leverageable risk management narrative that brings advanced analytics, risk finance/hedge theory, efficient frontier analysis, portfolio analysis and modelled risk actuarial tools together into an enterprise-wide platform. The narrative is unique in that it supports an enterprise risk finance strategy across hazard, operational, market, reputational and human capital risk domains. Figure 1 demonstrates the approach.

When next gen finance is utilized within a captive structure, companies find they are better positioned to combat unbudgeted or unforeseen price increases, maintain control over their insurance programs, and gain access to reinsurance market capacity. These are benefits that can ultimately transcend market conditions; hard or soft.

This article was submitted by the Hawaii Captive Insurance Council (HCIC), on behalf of and with support from its long-standing partner- member, Aon.

Authors: Ward Ching, managing director, Western region practice leader, Aon captive & insurance management, and a former director and current chair of the HCIC’s website committee; Christian Coleianne, director–actuarial & analytics, Aon; Zoë Rico, director & actuary, US–actuarial & analytics, Aon; Joseph Rizzo, director & actuary, US–actuarial & analytics, Aon; and Stephanie Vogel, director–actuarial & analytics, Aon.

Visit: www.hawaiicaptives.com