Ryskex
Magnify reinsurance capacity to the world’s largest capital markets
A new captive insurance blockchain-based ecosystem, DREx, connects captive managers, insurers, owners, developers, and other service providers, using parametric tools commonly found in the ILS market. Marcus Schmalbach and Nils Vogelsang of Ryskex report.
“Vermont is rightly called the ‘gold standard captive insurance domicile’.”
Marcus Schmalbach, Ryskex
Today’s global companies are forced to deal with a variety of risks. In addition to traditional risks, a stronger emphasis is being placed on intangible assets, climate change, and risks that arise from digitisation. At the same time, “black swan” events including 9/11 (terrorism), subprime crises (macro-economic) and, currently, COVID-19 (pandemic) are occurring with increasing frequency.
The triggers vary, but the impact is felt globally. Empirical values and experiences ensure that traditional risks no longer present an existential threat to business. We have reached the point where intangible assets (eg, brand and reputation), business interruption, climate change and cyber are of much greater importance for the continued existence of a company.
It is therefore necessary to address these new and emerging risks with innovative solutions, such as contemporary legislation and modern hedging approaches. Not all risks are transferred to an insurer; even if the companies would like them to be, insurers will not accept all risks. Many are uninsurable, or insurable to only a limited extent.
Uninsurable risks can pose a significant threat to the future of a company. They face a risk landscape that has been reconstituted in recent years. This is not only the result of structural changes in the economy, but of notable changes in the legal environment, and new forms of risk stemming from digitisation and globalisation, including global political changes and technological innovations.
Opportunities for captives
“There will be innovative solution approaches such as parametric risk trading for hard-to-cover, hard-to-place risks.”
Nils Vogelsang, Ryskex
Traditional insurance is based on the concept of indemnity and the law of large numbers. There must be a demonstrable and calculable loss that can then be used to justify a payment, in compensation for the direct and actual loss sustained. The challenge is that, in the hazy fog of intangibles, financial values and damage, it is hard to pin down.
This is where parametric risk trading comes in. The beauty of this is that it is free from the concept of demonstrable asset damage: you don’t need to figure out what a particular asset is worth. Parametric risk trading is as simple as an if/then statement: if this, then pay that. All that is needed is a trigger and a payout mechanism.
Global capital markets are very familiar with parametric triggers since they are what drive derivative contracts such as stock and bond options. The global market for derivatives has a notional principal value of $175 trillion, which corresponds to 350 times the capacity of the reinsurance market. The capital markets, with “their long familiarity with the underlying concepts”, are a natural fit for parametric concepts.
This explains the growth of insurance-linked securities (ILS). In 2019, some $11 billion of ILS risk capital was issued, which brings the total figure to an estimated $40 billion. The good news for captives is that the growing ILS market offers the potential for them to become profit centres, as opposed to cost centres.
The fundamental linchpin of pricing risk comes down to knowledge: the more you know, the more accurately you can price the risk.
Captives as profit centres
Between a captive and its parent company, we can assume a high degree of information symmetry. After all, they are part of the same entity, so it is unlikely that there are any skeletons in the closet yet to be discovered. The parent pays a premium to the captive. If the captive can then place this risk elsewhere at a lower premium, it will become a corporate profit centre.
In the traditional captive insurance model, risk is placed through underwriters and reinsurers. The premiums are higher because of the information asymmetry, along with the administrative costs. But if the risk is bundled in a structure which fits—and can therefore be placed—in the global capital markets, the costs can be dramatically reduced.
Parametric risk trading eliminates the arduous and lengthy claims process and reduces broker and administrative fees. Some models suggest that the potential cost savings through parametric solutions can be as high as 45 percent. With cost savings of this magnitude, lower premiums are clearly possible and may be low enough to turn the captive into a profit centre.
The mixing of the captives industry with the capital market seems to be a logical consequence and answer to the prevailing volatile, uncertain, complex, and ambiguous world. It creates a win-win situation. Captives can take and trade bigger risks—that are harder to price—from their parent companies. At the same time, the capital market and its participants can expand their investment portfolio (risk as an asset class).
The core of this symbiosis is index-based, also known as parametric risk trading. These solutions, in turn, accelerate the development of technologies such as blockchain and artificial intelligence (AI).
Interim conclusion
Excessively high premiums; an inefficient, non-digitised value chain; complex, non-tailor-made coverage concepts; and a claims settlement process that takes too long: these are just some of the current pain points for insurance buyers and captives managers. There is little or no interest in re/insurers covering systemic and emerging risks, as their actuarial approach is difficult—or impossible—to calculate, due to a lack of data and information.
The future of the captive insurance landscape will be digital, characterised by parametric solution concepts and “overnight” claims settlement. At the same time, the capital market will become much more important, as it is 350 times larger than the reinsurance market. It is also much further ahead in its digital journey than industrial insurance.
The margin call will replace the traditional claim adjustment, the claim adjuster will be replaced/supported by indices, 100-page contracts will be replaced by a one-page “smart contract”. No insurance cover is purchased, but risk is traded as an asset class.
Captives are transformed from cost to profit centres. Qualitative market research with various representatives of the capital market showed that there is a lot of interest in such a model and the possibility of creating a new asset class. The future of the captive insurance industry is digital, parametric, efficient and at home in Vermont.
The captive of tomorrow
The DREx (Digital Risk Exchange) ecosystem based in Vermont is what a leading captive domicile of the future will look like (Figure 1). Consider the following features:
Ecosystem
Vermont is rightly called the ‘gold standard captive insurance domicile’. Here the experts of the industry are at home as early adopters of innovations in risk management and processes. The digital transformation of the industry—led by blockchain technology—will be another milestone in the innovative power of the State of Vermont and its market participants.
The expansion of this network to include Ryskex as a technology enabler, and the financial power of the capital market, complement this network to ensure Vermont’s dominance—even in a digital future.
Risk trading platform
A risk trading platform will enable development of peer-to-peer risk placements and direct transfer from risk trader to risk taker, being a trading platform for traditional but also emerging risks. There will be innovative solution approaches such as parametric risk trading for hard-to-cover, hard-to-place risks such as intangible assets, non-damage business interruption, cyber, climate change and terrorism.
Standardised risk exchange
It will be a risk exchange based on blockchain and driven by AI that links demand (captives) and supply (third-party captives, reinsurers, investment banks and funds). Due to the smart contract structure, contracts can be negotiated, fixed and documented within 48 hours.
Claims solution
It will be a claims process based on automated rules called “triggers” and confirmed by independent third parties called “veritas”, driven by smart contracts in the blockchain to speed up the adjustment, management and settlement of claims and payment.
Figure 1: DREx ecosystem participants
Conclusion and outlook
Blockchain, AI and the internet of things are emerging technologies which promise to transform the captive insurance industry and serve as a toolkit to solve problems in the industry. What is needed is a standardised risk-trading platform that turns the most promising elements of this emerging insurtech into a tool that captive insurers can use to manage emerging risks which the insurance industry otherwise struggles to manage.
We need people and organisations to use them. Market participants must understand their potential, and not view them as a threat.
DREx is a joint project created by the Vermont Captive Insurance Association, the State of Vermont and Ryskex. It serves as a starting point, bringing together a working group in Vermont. Captive owners and professionals are welcome to showcase the potential of the technology outlined above to enhance Vermont’s dominance in the captive insurance industry. Marcus Schmalbach is chief executive officer at Ryskex. He can be contacted at: schmalbach@ryskex.com Nils Vogelsang is a user experience expert at Ryskex. He can be contacted at: vogelsang@ryskex.com
