Unlock the Potential of Alternative Risk Transfer Solutions

Unlock the Potential of Alternative Risk Transfer Solutions
November 4, 2024 8 mins

Unlock the Potential of Alternative Risk Transfer Solutions

Unlock the Potential of Alternative Risk Transfer Solutions

Risk managers are increasingly looking to Alternative Risk Transfer Solutions for potential enhancements in managing risk.

Key Takeaways
  1. Companies may find that traditional insurance solutions don’t meet their needs amid rapidly changing risks and business uncertainty.
  2. Challenging market conditions across certain lines are further highlighting the value of alternative risk transfer solutions.
  3. Risk managers can incorporate alternative risk transfer solutions into their risk strategies to build a more comprehensive, cost-effective and flexible risk approach that safeguards the business and its performance.

Growing supply chain complexity, climate change, cyber security threats, geopolitical tension — these are just some of the factors altering the business landscape. Companies are managing risks that are changing rapidly and unpredictably, and many find that traditional insurance products haven’t kept pace. As a result, companies face coverage gaps, claims payment delays and premium cost hikes, among other issues.

Risk managers are responding by increasingly looking to alternative risk transfer (ART) solutions for potential enhancements in managing risk, optimizing total cost of risk (TCOR), mitigating insurance pricing volatility and accessing risk capital more strategically. Enabled by both data and analytics and a problem-solving lens, ART solutions can help companies not only cover risk and manage volatility, but also protect balance sheets and create a foundation for growth. Today, brokers, risk managers, boardroom stakeholders and industry players are assessing how innovative ART solutions can rise against their clients’ greatest challenges. 

Turning to ART Solutions: What to Know

All companies considering ART solutions should start with their objectives and what they’re trying to solve — doing so will help form a tailored, strategic solution that complements their broader risk management and risk financing strategy. Some companies might be focused on natural catastrophes and climate volatility, where insurance capacity is shrinking; others might need non-physical damage business interruption insurance to manage cash flow when unexpected events disrupt operations. 

Taking a data-driven approach can help businesses understand exposures — both the expected risks and the range of probabilities that can occur in a changing risk landscape. From there, companies can establish their risk appetite and tolerance, assess the available insurance and risk financing solutions and find the strategic mix that works best for them. Experts can arm risk managers and the C-suite alike with data and modeling to help make decisions that support the organization’s risk and business strategy — and in turn, protect against risks, such as non-damage business interruption, which is not typically covered by traditional insurance.

There are several alternative solutions companies can use to access capital, manage costs and target growth. Parametric solutions, structured solutions and captives all provide financial value and flexibility as part of the overall risk management strategy. 

Parametric Solutions 

Parametric insurance has increasingly been on companies’ radars, especially in hard markets like global property, where natural catastrophe losses and other risks present challenges. The global parametric market is expected to grow significantly, indicating demand from businesses. Transparency, flexibility and speed of liquidity are some of the key reasons why companies are turning to parametric solutions as part of their risk management strategy and determining how they fit within the broader suite of risk management tools. 

Parametric works on an “if-then” basis, tied to a pre-defined event triggering an agreed payout rather than a “traditional” claims adjustment for actual loss sustained. Coverages are available for existing and emerging risks, from natural catastrophes to non-physical damage, cyber, supply chain issues and more. The increasing severity and frequency of natural catastrophes is pushing parametric solutions to the top of many risk managers’ agendas. 

For example, a retailer that sells goods shipped through an earthquake-exposed port can’t traditionally insure the port even though shipments could be affected. With a parametric policy, that retailer can cover its losses if a pre-defined level of disruption (that is, the parameter) is reached. Similarly, parametric coverage can provide the liquidity to allow employers to support employees when a natural disaster occurs in their area and wipes out internet access or causes destruction to their town and homes — ultimately helping to manage business continuity. 

With companies challenged by growing business complexity, including their supply chains, parametric solutions provide a simpler and more straightforward way to cut through the process. Not only does parametric often cover emerging risk or more innovative areas that traditional insurance hasn’t yet sufficiently addressed, but associated claims settlement is swift, enabling efficient recovery and resilience. 

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Because parametric solutions are designed, structured and calibrated to solve specific problems — and companies are already witnessing this themselves — they can advance a comprehensive risk strategy.

Cole Mayer
Global Head of Parametrics

Structured Solutions

Core to the landscape of alternative risk solutions for property and casualty risks is a set of risk financing techniques that can be collectively referred to as structured solutions.

Structured solutions represent a data-driven and creative approach to addressing risk transfer challenges, typically incorporating multiyear terms and loss-sensitive approaches. These solutions gain attention during difficult market conditions as clients eye alternatives, but the value proposition is compelling regardless of market cycles. They’re highly tailored based on an organization’s need. 

Consider, for example, a retail organization facing very high property risk transfer costs. The organization may not have had bad loss experience, but due to a combined impact of exposure growth, inflation and insurance market conditions, market rates exceed what the company views as viable. By implementing multiyear solutions to replace this capacity, based on actual loss experience, the organization can manage its risk more cost-effectively and work out its own risk/reward calculations. For less frequent risks that companies are willing to take on, and depending on how the solution is structured, an organization could  save more than half their risk transfer costs, depending on their own performance over time.

With a solution like this in place, companies further insulate themselves from market volatility. They can gain additional upside as investments in loss engineering are implemented, and also can better align their approach to risk with how capital is deployed by insurers.

Captives

The use of captives has increased significantly as the risk landscape has evolved and as data and analytics play an increasingly critical role in risk management. Twenty-five percent of respondents in Aon’s latest Global Risk Management Survey reported they currently use a captive, up from 17 percent in 2021. Captive insurance can help companies fund non-insurable risks, retain more risk, stabilize costs over time, guard against insurance market volatility and access reinsurance market capacity. 

Risk managers making a case for captives can link the approach to the company’s overall business strategy and operational health. Like parametric solutions, captives can be tailored to an organization’s objectives and overarching approach to risk management. Exploring a captive can highlight gaps in a company’s risk strategy, including visibility into areas such as claims management. It can also help identify areas in which the company could retain more risk and spend less on premiums, freeing up capital for other investments. And because the captive is designed to meet a company’s specific needs, it is often more cost-efficient than traditional solutions, in which the same coverages might be more expensive or not available at all. 

Captives are more relevant for emerging risks that are difficult to insure due to data scarcity. In such a scenario, a captive can be used to finance risks, thereby providing a platform for organizational capital to be deployed to manage the associated volatility. It can additionally act as a mechanism to gather data points that can be used to build an underwriting model and attract external insurance capital over time.

Organizations have also used captives to configure optimal risk financing outcomes effectively, blending and connecting all available forms of capital to their risk. For instance, using advanced analytics, organizations can use their own capital (calibrated to their risk appetite and tolerance), as well as traditional insurance capital and ART approaches (such as parametric insurance and structured solutions), to optimize TCOR and ensure they are accessing the best risk financing outcomes available.

Getting Started 

While ART conversations often arise during insurance renewals, risk management and making strategic improvements that materially impact the business are year-round endeavors. Exploring parametric insurance, structured solutions and captives should start early so risk managers are better informed and armed with the necessary data to build a comprehensive risk management approach that supports both short- and long-term business goals. Starting with the company’s objectives and needs helps brokers and insurers match current and new solutions with the right risks to meet a company’s evolving business and requirements — providing better costs, more flexibility and the confidence to grow. 

Aon’s Thought Leaders
  • Michael Gruetzmacher
    Head of Alternative Risk Transfer and Innovation, North America
  • Ciaran Healy
    EMEA Chief Commercial Officer
  • Cole Mayer
    Global Head of Parametrics

General Disclaimer

This document is not intended to address any specific situation or to provide legal, regulatory, financial, or other advice. While care has been taken in the production of this document, Aon does not warrant, represent or guarantee the accuracy, adequacy, completeness or fitness for any purpose of the document or any part of it and can accept no liability for any loss incurred in any way by any person who may rely on it. Any recipient shall be responsible for the use to which it puts this document. This document has been compiled using information available to us up to its date of publication and is subject to any qualifications made in the document.

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