Alternative Risk Transfer24th November 2020
The alternative risk transfer (ART) market is a portion of the insurance market that allows companies to purchase coverage and transfer risk without having to use traditional commercial insurance. The ART market includes risk retention groups (RRGs), insurance pools, and captive insurers, wholly-owned subsidiary companies that provide risk mitigation to its parent company or a group of related companies.
Alternative risk transfer (often referred to as ART) is the use of techniques other than traditional insurance and reinsurance to provide risk-bearing entities with coverage or protection. The field of alternative risk transfer grew out of a series of insurance capacity crises in the 1970s through 1990s that drove purchasers of traditional coverage to seek more robust ways to buy protection.
Most of these techniques permit investors in the capital markets to take a more direct role in providing insurance and reinsurance protection, and as such the broad field of alternative risk transfer is said to be bringing about a convergence of insurance and financial markets.
The alternative risk transfer market has two primary segments: risk transfer through alternative products and risk transfer through alternative carriers. Transferring risk to alternative carriers entails finding organizations, such as captive insurers or pools, that are willing to take on some of the insurer’s risk for a fee. Transferring risk through alternative products entails the purchase of insurance policies or other financial products such as securities.
Companies have a number of options when choosing an alternative carrier to adjust the amount of risk that they have in their portfolio. The largest portion of the alternative carrier market is self-insurance.
Self-insurance is when a company or individual sets aside its own money to pay for a possible loss rather than purchasing insurance with another company to reimburse them for any loss. With self-insurance, any costs are paid by the individual or company that suffers the loss rather than filing a claim under an insurance policy. In the case of a company, self-insurance could apply to health insurance. An employer that provides health or disability benefits to employees might fund claims from a specified pool of assets rather than through an insurance company. The employer avoids having to pay insurance premiums to a third party but retains the full risk of paying claims.
While still regulated by state insurance commissions, self-insurance allows the company to reduce costs and streamline the claims process. Coverages that are common among self-insurers include workers’ compensation, general liability, auto liability, and physical damage. Despite the fact that both workers compensation and auto liability are heavily regulated by the various states, growth of self-insurance in these two lines has continued. Since self-insurance is typically associated with cost efficiency and increased loss control.
Risk-retention groups and captive insurance tends to be more popular with large corporations. Pools are more commonly used by businesses that face the same risk as it allows them to pool resources to provide insurance coverage. Pools are also often associated with groups of governmental entities that band together to cover specific risks. Most frequently, pools have been established to deal with workers’ compensation coverage. Since workers compensation is one of the most troubled lines of coverage, interest in pools persists.
A number of insurance products are available on the ART market. Several of these options, such as contingent capital, derivatives, and insurance-linked securities, are closely associated with debt and bond issues as they involve issuing a bond. Proceeds from the bond issue are invested to increase the amount of funds available to cover liabilities while bondholders receive interest. Securitization involves bundling the risk of one or more companies together, and then selling that risk to investors who are interested in gaining exposure to a particular risk class.
Alternative Risk Transfer Products Categories
1) Uncommon mediums used for common risks
- Risk Retention Groups (RRG): self-insurance capital (money) contributed by several companies that can range from small to medium in size.
- Self-Insured Retentions (SIR): capital (money) set aside to be used when losses occur.
- Earnings Protection: policies that are available by specific loss of earnings in a certain financial period.
- Captives: a side insurance company (subsidiary) that insures a parent company only.
- Rent-a-Captives: captives that are shared among several companies that are not the parent company, but funds are controlled by the parent company.
- Finite Insurance: multi-year insurance policies.
- Multi-Trigger Policies: policies that are triggered by distinct events within a distinct time frame.
- Integrated risk: policies that cover a variety of distinct risks (some of them not being common insurance risks).
2) Mediums based in capital markets
- Securitization: the procedure when risks are merged into debt/equity instruments that can be traded in the financial markets.
- Insurance-linked bonds: bonds that lose their principal/interest in full or partially if a predetermined event happens.
- Contingent Surplus Notes: notes that supply holders with capital (money) when a loss occurs.
- Weather Derivatives: policies made available by certain meteorological events of certain extremities happen.
- Cat-E-Puts (Catastrophe Equity Put Options): options that permits a company to sell/issue equity at a set price in case a certain catastrophe happens
The major market of alternative risk transfer is through self-insurance, where companies are still regulated by the government but it allows a company to have self-efficiencies through reducing costs and allowing a faster claims process. The alternative risk transfer market gives a company many types of choices in regards to policy-making, giving it a customized nature. The features of alternative risk transfer are that it allows the consumer to get a policy that matches their unique needs, coverage can be obtained for several years and for more than one line. In addition, due to their non-traditional nature of business, much of the risk covered under alternative risk transfer is mainly obtained through the transfer of said risk to the capital markets, allowing companies to source its capital. The non-traditional nature of alternative risk transfer thus allows those with different needs, from regular insurance customers, to get risk management that fits their needs.