Nerves jangle but ART solutions forge ahead
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Nerves jangle but ART solutions forge ahead

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We delve into the evolving world of alternative risk transfer (ART) amidst challenges like the Vesttoo scandal, the growth of captives, parametric solutions, and emerging risks.

The world of alternative risk transfer (ART) looked to be continuing its smooth forward trajectory, with growing interest in an ever widening range of solutions, when a complex fronting arrangement involving fintech start-up Vesttoo and allegedly fraudulent letters of credit from the Bank of China dramatically unravelled earlier this summer.

This has quickly moved to the courts but, as it does, the market fervently hopes this is an isolated scandal and that any contagion can be quickly contained.

“It may be too early to tell what happens next”, says Dan Ryan, a senior director in AM Best’s property/casualty ratings division.

It may be too early to tell what happens next
Dan Ryan Senior Director, AM Best
Dan Ryan.jpg

“Rest assured though, many fronting carriers and risk managers alike are keener than ever before. The use of letters of credit have been a key part of the industry for decades, so they’ll likely be around for many years to come. At a minimum, the industry will have to find a way to validate these financial instruments and establish internal controls and processes that will lend itself to that as well. An event such as this just raises the bar when it comes to ERM [enterprise risk management] and how effective management has been when managing counterparty risk. No doubt auditors also will be paying closer attention to this in their upcoming audits.”

While some in the market look at Vesttoo and query how its structures were reportedly so much cheaper than similar placements with established markets, there is an acceptance than everyone is going to have to be a lot more thorough when looking under the bonnet of complex deals.

“Vesttoo has highlighted the need for forensic due diligence throughout the capital supply chain. I do not think this scandal will impact the current successful fronting insurers as they have partnered with excellent reinsurance capacity. It does highlight however that there is no room for complacency”, says Mike Keating, chief executive of the Managing General Agents Association.

Captives and Innovation in ART

Elsewhere, the world of ART feels buoyant, having lost none of the creativity that has seen a myriad of new solutions emerge over the last decade.

Vesttoo has highlighted the need for forensic due diligence throughout the capital supply chain
Mike Keating Chief Executive, Managing General Agents Association
Mike Keating MGAA pic.jpg

Captives continue to grow relentlessly in the face of continuing pressures on capacity and rates, says Derrick Easton, managing director, alternative risk transfer solutions for WTW in New York.

“There is continued growth in captives fuelled by the challenging property insurance market and hard market in general, but also to provide corporates with greater control over risk financing arrangements.

“The growth in sophisticated analytics has allowed captives to leverage diversification in the insured portfolio and access reinsurance at levels which reflect the risk tolerance and appetite of the group … Captives are actively participating in larger retentions, quota-share participation in layers which can’t be fully placed or vertically within a programme tower.”

There is also plenty of innovation within this growth says Grant Maxwell, global head of alternative risk transfer at Allianz Commercial.

“We have seen a lot of interest in virtual captives which use a variety of structures to mimic a captive and may roll forward over time to become fully-fledged captives. There are some clients who don’t want a captive while others who might want to go down the captive route later. Each one is different but they deliver the same economic benefits as formal captives”.

He also pointed to corporate tax changes in France, which have made it more advantageous to domicile a captive in France, as another growth driver.

Multi-Year Arrangements and Their Controversy

There is continued growth in captives fueled by the challenging property insurance market and hard market in general
Derrick Easton Managing Director, Alternative Risk Transfer Solutions, WTW

Another traditional tool in the risk manager’s ART toolbox has been multi-year – and often multi-class – arrangements. These have come under the spotlight in the tough market conditions that have prevailed at recent renewals and will continue to do so, says Ryan:

“Looking at what the Fed has done to interest rates and credit tightening in one year, or looking at where US Treasuries have gone as a result and what impact that’s had on the financial services sector, insurance included, one has to wonder why anyone want to lock themselves into a multi-year deal given how quickly things can change. See how quickly inflationary pressures have impacted consumer goods and the rapid evolution of artificial intelligence. See how supply chain issues and labour costs have affected businesses. I’m not sure why anyone would lock into financial contracts today without seeking a premium for the risk they’d be taking on.

Others do not take such a jaundiced view of the prospects for multi-year deals. “I have heard that in a hard market some say that multi-year arrangements are not good because they lock in higher rates”, says Maxwell.

We have seen a lot of interest in virtual captives which use a variety of structures to mimic a captive and may roll forward over time
Grant Maxwell Global Head of Alternative Risk Transfer, Allianz Commercial

“This is not the way we look at them. They offer more consistency of insurance spend over a market cycle and focus firms on their own risk retention. They also reduce the administrative burden of the annual renewal”.

Brokers, too, see the benefits of multi-year arrangements in the current market conditions, according to Easton. “The multi-year structured risk financing market has never been more active where the value in longer-term certainty of capacity, coverage and cost is imperative in today’s volatile insurance market.

“The pivot of insurers in this sector has been from multi-year and multi-line 100% risk transfer programmes into multi-year, often single line, structured programmes where at least one, if not two, limit losses are pre or post loss financed. In many cases, these structured risk financing programmes sit as reinsurance of a captive.”

The Rise of Parametric Solutions

Some of the greatest excitement among ART specialists surrounds the growth of parametric solutions.

“There is definitely tremendous momentum in the parametric sector with more risk protection sellers offering parametrics and many MGAs leveraging the availability of data and computer processing speeds to create platforms that offer easy access to data visualisation and product structuring for potential buyers”, says Claire Wilkinson, managing director, alternative risk transfer solutions for WTW in London.

There is definitely tremendous momentum in the parametric sector with more risk protection sellers offering parametrics
Claire Wilkinson Managing Director, Alternative Risk Transfer Solutions, WTW

“This is the new hot topic for many risk managers and captive owners, fuelled by the climate change agenda and regulatory reporting requirements.”

Maxwell agrees that interest in parametric solutions is being driven by a range of factors, including public-private partnerships in developing countries: “If a supra-national organisation wants to support farmers in Africa, having a parametric solution that pays out on weather data rather than actual loss, which might be difficult to measure, is very attractive”.

Wilkinson says the growth of parametric covers is likely to continue: “The attractions are simple: transparency, and simplicity of policy structure, rapid claims settlement without loss adjustment, broader coverage including non-damage business interruption and flexibility in the use of claim proceeds. All of these are being leveraged by many insureds to create a liquidity injection at the time of crisis which can be used to repair damaged assets, supplement lost revenue, cover extra expense, aid employee and community recovery or to pay debt service.”

ART solutions are finding traction across the board as lines like directors’ and officers’ continue to suffer extreme volatility in rates and capacity, while new risks in cyber, renewable energy and carbon capture start demanding a slice of the market’s available capital. The market will be hoping it can navigate these challenges without having to pick its way around too much fallout from the Vesttoo scandal.


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