Alternative Risk Transfer
Encyclopedia
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.
s and reinsurance sidecar
s.
Standardization and trading of risk in non-indemnity form is another area of alternative risk transfer and includes industry loss warranties.
In addition, a number of approaches involve funding risk transfer, often within the structures of the traditional reinsurance market. Captive insurance
companies are formed by firms and re/insurers to receive premiums that are generally held and invested as a "funded" layer of insurance for the parent company. Some captives purchase excess of loss reinsurance and offer coverage to third parties, sometimes to leverage their skills and sometimes for tax reasons. Financial reinsurance
in various forms (finite, surplus relief, funded, etc.) consists of various approaches to reinsurance involving a very high level of prospective or retrospective premiums relative to the quantity of risk assumed. While such approaches involve "risk finance" as opposed to "risk transfer," they are still generally referred to under the heading of alternative risk transfer
Alternative risk transfer is often used to refer to activities through which reinsurers or insurers transform risks from the capital markets into insurance or reinsurance form. Such transformation can occur through the policy itself, or through the use of a transformer reinsure, a method important in credit risk markets, hard asset value coverage and weather markets. Reinsurers were notable participants in the early development of the synthetic CDO and weather derivative markets through such activities.
A subset of activities in which reinsurers take capital markets risks is dual-trigger or multiple trigger contracts. Such contracts exist between a protection buyer and a protection seller, and require that two or more events take place before a payment from the latter to the former is "triggered." For example, an oil company may desire protection against certain natural hazards, but may only need such protection if oil prices are low, in which case they would purchase a dual trigger derivative or re/insurance contract. There was a great deal of interest in such approaches in the late 1990s, and re/insurers worked to develop combined risk and enterprise risk insurance. Reliance Insurance extended this further and offered earnings insurance until the company suspended its own business operations. This area of alternative risk transfer activity diminished after the general hardening of the commercial insurance and reinsurance markets following the 9-11 terrorist attacks.
Another area of covergence is the emergence of pure insurance risk hedge funds, that function economically like fully collaterallized reinsurers and sometimes operate through reinsurance vehicles, but take the form of hedge funds.
Life insurance companies have developed a very extensive battery of alternative risk transfer approaches including life insurance securitization, full recourse reserve funding, funded letters of credit, surplus relief reinsurance, administrative reinsurance and related trechniques. Because life reinsurance is more "financial" to begin with, there is less separation between the conventional and alternative risk transfer markets than in the property & casualty sector.
Emerging areas of alternative risk transfer include intellectual property insurance, automobile insurance securitization and life settlement
s. It should be possible to adapt these instruments to other contexts. It has, for example, been suggested adapting cat bonds to the risks that large auditing firms face in cases asserting massive securities law damages.
, Bank of America
, and Citibank
.
Insurers; there are Wikipedia articles on: AIG
, Zurich
, USAA
, and XL Capital
Reinsurers; there are Wikipedia articles on: Munich Re
, Hannover Re
. and Swiss Re
.
Brokers; there are Wikipedia articles on: Willis
, Marsh
, Aon Corporation
Consultants; there are Wikipedia articles on Tillinghast
, Mercer (consulting firm)
, and Watson Wyatt.
Sovereigns: Mexico is the only national sovereign to have issued cat bonds (in 2006, for hedging earthquake risk; in 2009, a multistructure instrument covering earthquake and hurricane risk)..
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.
Areas of activity
A major sector of alternative risk transfer activity is risk securitization including catastrophe bondCatastrophe bond
Catastrophe bonds are risk-linked securities that transfer a specified set of risks from a sponsor to investors...
s and reinsurance sidecar
Reinsurance Sidecar
Reinsurance sidecars, conventionally referred to as "Sidecars," are financial structures that are created to allow investors to take on the risk and return of a group of insurance policies written by an insurer or reinsurer and earn the risk and return that arises from that business...
s.
Standardization and trading of risk in non-indemnity form is another area of alternative risk transfer and includes industry loss warranties.
In addition, a number of approaches involve funding risk transfer, often within the structures of the traditional reinsurance market. Captive insurance
Captive insurance
Captive insurance companies are insurance companies established with the specific objective of financing risks emanating from their parent group or groups, but they sometimes also insure risks of the group's customers as well...
companies are formed by firms and re/insurers to receive premiums that are generally held and invested as a "funded" layer of insurance for the parent company. Some captives purchase excess of loss reinsurance and offer coverage to third parties, sometimes to leverage their skills and sometimes for tax reasons. Financial reinsurance
Financial reinsurance
Financial Reinsurance , is a form of reinsurance which is focused more on capital management than on risk transfer. In the non-life segment of the insurance industry this class of transactions is often referred to as finite reinsurance....
in various forms (finite, surplus relief, funded, etc.) consists of various approaches to reinsurance involving a very high level of prospective or retrospective premiums relative to the quantity of risk assumed. While such approaches involve "risk finance" as opposed to "risk transfer," they are still generally referred to under the heading of alternative risk transfer
Alternative risk transfer is often used to refer to activities through which reinsurers or insurers transform risks from the capital markets into insurance or reinsurance form. Such transformation can occur through the policy itself, or through the use of a transformer reinsure, a method important in credit risk markets, hard asset value coverage and weather markets. Reinsurers were notable participants in the early development of the synthetic CDO and weather derivative markets through such activities.
A subset of activities in which reinsurers take capital markets risks is dual-trigger or multiple trigger contracts. Such contracts exist between a protection buyer and a protection seller, and require that two or more events take place before a payment from the latter to the former is "triggered." For example, an oil company may desire protection against certain natural hazards, but may only need such protection if oil prices are low, in which case they would purchase a dual trigger derivative or re/insurance contract. There was a great deal of interest in such approaches in the late 1990s, and re/insurers worked to develop combined risk and enterprise risk insurance. Reliance Insurance extended this further and offered earnings insurance until the company suspended its own business operations. This area of alternative risk transfer activity diminished after the general hardening of the commercial insurance and reinsurance markets following the 9-11 terrorist attacks.
Another area of covergence is the emergence of pure insurance risk hedge funds, that function economically like fully collaterallized reinsurers and sometimes operate through reinsurance vehicles, but take the form of hedge funds.
Life insurance companies have developed a very extensive battery of alternative risk transfer approaches including life insurance securitization, full recourse reserve funding, funded letters of credit, surplus relief reinsurance, administrative reinsurance and related trechniques. Because life reinsurance is more "financial" to begin with, there is less separation between the conventional and alternative risk transfer markets than in the property & casualty sector.
Emerging areas of alternative risk transfer include intellectual property insurance, automobile insurance securitization and life settlement
Life settlement
A life settlement is a financial transaction in which the owner of a life insurance policysells an unneeded policy to a third party for more than its cash value and less than its face value. Until recently, if a policyowner opted out of a policy by surrendering the policy or allowing it to lapse,...
s. It should be possible to adapt these instruments to other contexts. It has, for example, been suggested adapting cat bonds to the risks that large auditing firms face in cases asserting massive securities law damages.
Key market participants
Banks; there are Wikipedia articles on: JPMorgan Chase, Goldman SachsGoldman Sachs
The Goldman Sachs Group, Inc. is an American multinational bulge bracket investment banking and securities firm that engages in global investment banking, securities, investment management, and other financial services primarily with institutional clients...
, Bank of America
Bank of America
Bank of America Corporation, an American multinational banking and financial services corporation, is the second largest bank holding company in the United States by assets, and the fourth largest bank in the U.S. by market capitalization. The bank is headquartered in Charlotte, North Carolina...
, and Citibank
Citibank
Citibank, a major international bank, is the consumer banking arm of financial services giant Citigroup. Citibank was founded in 1812 as the City Bank of New York, later First National City Bank of New York...
.
Insurers; there are Wikipedia articles on: AIG
American International Group
American International Group, Inc. or AIG is an American multinational insurance corporation. Its corporate headquarters is located in the American International Building in New York City. The British headquarters office is on Fenchurch Street in London, continental Europe operations are based in...
, Zurich
Zurich Financial Services
Zurich Financial Services AG is a major financial services group based in Zurich, Switzerland.-History:The Company was founded in 1872 as subsidiary of the Schweiz Marine Insurance Company under the name Versicherung Verein...
, USAA
USAA
United Services Automobile Association is a Fortune 500 financial services company offering banking, investing, and insurance to people and families that serve, or served, in the United States military. In 2011, there were 8.4 million members. The company reported a net worth of $19.3 billion in...
, and XL Capital
Reinsurers; there are Wikipedia articles on: Munich Re
Munich Re
Munich Re Group is a reinsurance company based in Munich, Germany. It is one of the world’s leading reinsurers. ERGO, a Munich Re subsidiary, is the Group’s primary insurance arm....
, Hannover Re
Hannover Re
Hannover Re , with a gross premium of around €11 billion, is one of the leading reinsurance groups in the world...
. and Swiss Re
Swiss Re
Swiss Reinsurance Company Ltd , generally known as Swiss Re, is a Swiss reinsurance company. It is the world’s second-largest reinsurer, after having acquired GE Insurance Solutions. The company has its headquarters in Zurich...
.
Brokers; there are Wikipedia articles on: Willis
Willis Group Holdings
Willis Group Holdings is a global insurance broker headquartered in the Willis Building, London, United Kingdom. It has more than 400 offices in 120 countries, and approximately 17,000 employees...
, Marsh
Marsh
In geography, a marsh, or morass, is a type of wetland that is subject to frequent or continuous flood. Typically the water is shallow and features grasses, rushes, reeds, typhas, sedges, other herbaceous plants, and moss....
, Aon Corporation
Consultants; there are Wikipedia articles on Tillinghast
Tillinghast
Tillinghast was the world's largest actuarial practice focused on insurance and a unit of Towers Perrin specializing in risk management and actuarial consulting...
, Mercer (consulting firm)
Mercer (consulting firm)
Mercer is a human resource and related financial services consulting firm, headquartered in New York City. The firm operates internationally in more than 40 countries, with more than 19,000 employees, and is the world's largest human resource consulting firm....
, and Watson Wyatt.
Sovereigns: Mexico is the only national sovereign to have issued cat bonds (in 2006, for hedging earthquake risk; in 2009, a multistructure instrument covering earthquake and hurricane risk)..
See also
- Captive Insurance CompaniesCaptive insuranceCaptive insurance companies are insurance companies established with the specific objective of financing risks emanating from their parent group or groups, but they sometimes also insure risks of the group's customers as well...
- ReinsuranceReinsuranceReinsurance is insurance that is purchased by an insurance company from another insurance company as a means of risk management...
- Catastrophe bondCatastrophe bondCatastrophe bonds are risk-linked securities that transfer a specified set of risks from a sponsor to investors...
s - Reinsurance SidecarReinsurance SidecarReinsurance sidecars, conventionally referred to as "Sidecars," are financial structures that are created to allow investors to take on the risk and return of a group of insurance policies written by an insurer or reinsurer and earn the risk and return that arises from that business...
s - Financial reinsuranceFinancial reinsuranceFinancial Reinsurance , is a form of reinsurance which is focused more on capital management than on risk transfer. In the non-life segment of the insurance industry this class of transactions is often referred to as finite reinsurance....
- Finite Risk insuranceFinite Risk insuranceFinite risk insurance is the term applied within the insurance industry to describe an alternative risk transfer product that is typically a multi-year insurance contract where the insurer bears limited underwriting, credit, investment and timing risk. The assessment of risk is often conservative...
- Contingent capital
- Captive insuranceCaptive insuranceCaptive insurance companies are insurance companies established with the specific objective of financing risks emanating from their parent group or groups, but they sometimes also insure risks of the group's customers as well...
- Dual trigger insuranceDual trigger insuranceDual Trigger insurance is an insurance program where the limit, premium, or retention are linked to one or more contingencies other than insurable hazards. Such contingencies are often external to the buyer, objectively measurable, and uncorrelated with the hazard risk covered under the program...
- Industry Loss WarrantiesIndustry Loss WarrantiesIndustry Loss Warranties, often referred to as ILWs, are a type of reinsurance or derivative contract through which one party will purchase protection based on the total loss arising from an event to the entire insurance industry rather than their own losses...
- Life Insurance Securitization
- Weather derivativesWeather derivativesWeather derivatives are financial instruments that can be used by organizations or individuals as part of a risk management strategy to reduce risk associated with adverse or unexpected weather conditions...
- Risk financingRisk financingIn business economics, risk financing is concerned with providing funds to cover the financial effect of unexpected losses experienced by a firm....
- Life settlementLife settlementA life settlement is a financial transaction in which the owner of a life insurance policysells an unneeded policy to a third party for more than its cash value and less than its face value. Until recently, if a policyowner opted out of a policy by surrendering the policy or allowing it to lapse,...
s - International Society of Catastrophe ManagersInternational Society of Catastrophe ManagersThe International Society of Catastrophe Managers is a professional association that promotes catastrophe management professionalism within the insurance industry.-Goal and objectives:...