Some senior corporate insurance buyers want the industry to think outside the box and offer more innovative products to plug gaps in risk coverage, but do insurers have the appetite? Stuart Fagg investigates
The past few years have undoubtedly been characterised by major change in the way organisations approach risk management. The emergence of enterprise risk, the appointment of chief risk officers and more sophisticated approaches to adding value through risk management have all moved risk management forward. As enterprise risk management (ERM) implementations begin to bear fruit in terms of a more complete picture of risk, so expectations on where insurance fits in have evolved.
“Having been through the ERM program and having identified a lot of risks in the business, many of which aren’t covered under our existing insurance programs, you start to wonder – in fact from a total risk management perspective, if these are the risks that we’re recognising in the business and these risks are not always insured, are we in fact spending our insurance dollar in the right place?” said Colin Knox, insurance director at Foster’s Group. “Then when you look at what those risks are and the way the insurance market is structured at the moment, you ask the second question, well if our current insurance program isn’t insuring all the risks that we have in the business, can in fact the insurance market provide a response to some of those risks that aren’t currently insured?” He added that of the risks most regularly appearing in surveys of senior risk professionals in recent years, traditionally can’t be dealt with through traditional insurance products. “From a high level, you’d look at that and say ‘well, gee, there aren’t really a lot of insurance companies that immediately spring to mind that responds to those risks’,” he said, referring to a study that placed brand and image as the top risk facing companies. “Now a lot of these actually resonate with Foster’s, and you kind of sit back and say ‘well how do I understand where insurance works and where it doesn’t work in all this?’”
That thought process led Knox to throw down a challenge to the insurance industry – use excess capital to fund innovative products. “Can the insurance market align it’s capital to be able to meet some of those risks going forward? I think the insurance market is starting to move in that direction,” Knox said.
“I mentioned that brand and risk can be insured and, in fact, there’s an insurance policy on the market now in London that actually will allow you to nominate certain risks and if they occur, and your brand and image or your reputation as it’s measured is effected by a share price or your earnings rather reduce as a result of it, then you can actually insure that now.”
According to Peter Kuczer, regional manager for Australasia multinational and risk management accounts at AIG, there is excess capital available. “The reality we have today is that there is excess capital in the traditional insurance market,” he said.
Knox agreed. “I think that they’re the sorts of things that we have to start looking at and saying where we’ve got excess supply of capital in the world of insurance, for example, marine insurance, property damage and business interruption insurance,” he said. “There’s a lot of capital out there for an offer to insure those risks, but in new areas there’s a gap where businesses, having gone through their ERM programs and having identified a plethora of different types of risks and having mapped them and found out there’s a mismatch here between what the insurance program covers and what the risks are that have been identified. Having identified that gap there’s a need for the insurance industry to sit down and say ‘well maybe we need to apply some of that capital into the area where industry and commerce going forward is going to need to put it aside from the traditional types of risks’.”
While Knox’s comments are being echoed by other senior risk professionals elsewhere in the world, some senior insurance professionals are unsure of whether there is appetite for the type of products being discussed – capital markets-based products, alternative risk transfer products and new coverages – and suggest this is ground that has been covered before.
“If you go back, from 2001 to say 2003, you’ll find numerous articles written about things like alternative risk transfer, alternative risk financing,” said Kuczer. “These types of products were in the market a number of years ago. By and large, worldwide capacity and appetite for those products is no longer active as at today.”
However, the past few years have seen real progress in the sophistication of enterprise risk management techniques and coverage, leading to a much better understanding of remaining exposures. “From time to time, certain organisations will come across exposures that the traditional insurance industry has no appetite for,” said Kuczer. “Or they may have an exposure which they know have, say the environmental exposure. They know they have this exposure and they have to somehow account for it, but it’s not an exposure that’s going to manifest itself today. It is going to manifest itself sometime in the future. Now you can’t deal with that kind of exposure through a conventional insurance product.”
According to Mick McKeever, manager, strategic risk at Marsh, a better understanding of what risks are being borne by an organisation – through better ERM – is leading to demand for less traditional insurance-type products. “What we’re looking at is in every opportunity the client is looking into – whether it be market development or whatever – there’s some risk associated with that. And what we try to do is work with them to properly identify that risk then work to try and assess it, quantify it and then go into the marketplace and actually try and find it,” he said. “Most can talk that language because that’s straight out of a risk management textbook. The magic work though is actually being able to treat the risks and if you’re just merely walking back into a traditional insurer asking ‘can you do this?’ you’re going to very quickly hit the wall. So you’ve then got to try and deal in markets that take it outside of the normal insurance market and in a lot of cases that means getting into the capital markets.”
The major advantage capital markets have is the depth of their pockets. The 2005 US hurricane season, which wreaked widespread and expensive havoc across the country, exposed a lack of capacity in hurricane insurance. According to McKeever, that led Marsh into the capital markets looking for a solution on behalf of a major client. “If we go into the traditional market in the hurricane season for three months in the States we’re finding that again rates were going through the roof, quadrupling and capacity was half, even in some case even down to further than what it was,” he said.
“For our larger clients that wasn’t an acceptable solution. Working with Morgan Stanley and Ace, Marsh developed MaRI (Marsh Risk Innovations) a first of its kind insurance facility designed to provide additional capacity to the depleted property catastrophe insurance market. This new facility is unique in that it delivers capital market capacity through an A+ rated insurer. It provides large corporate clients of Marsh with exclusive access to insurance capacity intended to fill the gaps that are creating instability and shortfalls in property catastrophe risk coverage.While primarily focused at the US property market it has application in other property catastrophe effected markets. We believe this approach could provide more than US$1 billion in total capacity over the next 12 months.”
In addition to capacity issues, post-September 11 insurance costs have also driven changes in how organisations, particularly large multinational groups, view insurance and risk transfer. “Insurance suddenly became not just a cost item that was somewhere down the profit and loss account,”
said McKeever of the impact of September 11. “It suddenly became top of mind because for most clients the cost of insurance post-September 11 was triple or quadruple. More importantly the retentions that they had to face went from the tens of thousands or in some cases the hundreds of thousands to, in cases, multiples of millions of dollars. So all of a sudden when the client is looking at the total cost of risk and the total cost of risk transfer, it became a massive number and we’re now traditionally seeing that for the major clients, insurance can be a number two or a number three cost on their profit and loss.”
While there is a real discussion occurring around these topics and there is no doubt that more sophisticated insurance style products that utilise the capital markets’ depth are increasingly available, observers believe there may be a limited market in Australia at present.
“Typically these types of products are really only attractive to established, sophisticated, and well financed clients,” said Kuczer. “They have to be the type of client that has the wherewithal to hold a fair amount of risk themselves. What they’re looking to do is really to plug the gaps and answer questions like ‘when are we the most vulnerable? What are we most vulnerable to?’ And often it’s a blend of something physical happening, at a time when other things are occurring at the same time. It is difficult to predict exact amplitude. But you know if those confluence of events occur, it’s going to hurt.”
Additionally, while the capital markets are well developed in North America, Australia is not a big market. “Australian markets driving the capital market is not going to happen,” said McKeever. “What drives the capital market is primarily the US and then secondly Europe and you’ll tend to find that it starts in the US, flows through Europe and then if there’s an application it might happen to one or two clients in Australia.”
And while demand and appetite for new and innovative solutions is likely to increase in the future, the conditions must be right.“My personal opinion is that we will see a re-emergence of these types of products, initiatives, call them solutions-driven arrangements, but it will happen when basically the right moons align,” said Kuczer. “Yes, the customers have to demand it, without a doubt, but the extent to which the insurance players respond to that is going to be driven more by financial concerns than by other concerns. When the right financial conditions are there, they will be prepared to invest in pursuing these opportunities, because invariably when these players were active in the market, the one thing that did happen is that they actually separated out capital to support these products from the capital that they were using to support traditional products.”
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