Alternative Carriers

The origin of the alternative risk transfer market was focussed on transactions that allowed entities to insure their own risks. These solutions emphasized the financing of risks rather than transfer of the risks to the commercial insurance market. In truth, most of the alternative carrier concepts incorporate a large portion of risk retention and involve little in the way of transfer; however, the ART name has been given to them and it has stuck.

• Self-Insurance--This segment of the carrier market is one of the oldest and still remains one of the largest. Currently, estimates indicate that self-insurance represents about 75% of the carrier market. Coverages that commonly fall into this segment are workers compensation, general liability, and 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, these alternatives are expected to continue to grow regardless of the market conditions.
• Captives and RRGs--By definition, captives and risk retention groups (RRGs) are insurance companies that are owned by their parent(s). The original captive "boom" was in the late 1960s; however, the recent hard market has broadened the appeal of the captive movement. For years, captives have been considered the exclusive domain of Fortune 500 companies but, today, middle market companies are also seeing the advantages of captive formations. As a result, captive domiciles across the country saw a record year for formations in 2003. Despite the continuation of the hard market, it will be difficult to continue this record pace.
• Pools--This ART technique is usually 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. The year 2003 saw significant growth in the pool concept and since workers compensation is one of the most troubled lines of coverage, interest in pools should continue during this current year and beyond.

Alternative Products

• Finite Risks--The past several years have seen finite risk products become an accepted risk mechanism. While these products are designed specifically to the needs of the customers, they are typically multiyear contracts that assist the customer in reducing their cost of capital via earnings smoothing. Finite risk products are long-term solutions that, by their nature, reduce the year-to-year volatility normally associated with a commercial insurance policy. Products can be written either on a pre-funded (prospective) or post-funded (retrospective) basis. Recently, a variety of applications have been successfully utilized to help purchasers resolve risk problems. Among the current crop of finite products are loss portfolio transfers, adverse development covers, time and distance covers and spread loss covers. To date, the most utilized finite product is the loss portfolio transfer, which is frequently used to eliminate long-term liabilities from a company during merger and acquisition activities. The smoothing effects of the finite risk products coupled with the current restricted capacity in today's marketplace will continue to favor the use of these products.
• Contingent Capital--These products, also referred to as commited capital, are one method to take advantage of the convergence of the insurance and capital markets. The underlying concept of committed capital is that the customer can sell some form of debt via a contractual commitment at a predetermined price should a specific adverse event occur. These products are only about 10 years old; however, they are catching on quickly since many people see them as a bridge between full insurance and full self-insurance. The current hard insurance market should continue to stimulate interest in this approach.
• Integrated Multi-line Products--The late '90s also saw the introduction of another new ART approach--the multiline--and, in many cases, multiyear integrated insurance product. These products were the first attempts to combine insurable risk with financial risks and were yet another sign of the converging capital and insurance markets. These products were heralded by some as the next big thing in risk management. However, due in large part to the events following 9/11, many insurers have moved back to their core businesses and deployed their capital in more traditional methods. As a result, with the exception of Swiss Re and Zurich, few carriers are offering these products today.
• Insurance-Linked Securities (aka Cat Bonds)--These products were developed specifically to offset the decrease in insurance capacity. They are designed to assist insurers and corporations in transferring catastrophic risks (wind, flood and earthquake) to the capital market via a bond issue. Originally, these products were used in response to the lack of wind coverage following Hurricane Andrew. Typically, these products come about as a result of a bond being issued, and the proceeds being invested. Bondholders then receive interest payments and the principal repayment over the life of the bond. However, should the issuer suffer a catastrophic loss, both the interest and principal could be used to pay the loss. While many believed that the hard market would accelerate the use of CAT bonds, utilization has been modest over the past few years. However, as the transactional costs decline and the acceptance of these products increases, usage is expected to grow.
• Weather Derivatives--As opposed to a lack of insurance capacity, the development of these products was directly tied to the deregulation of the U.S. energy industry. Energy companies needed to find ways to mitigate the significant ear
• nings volatility that was usually associated with changes in weather. Weather derivatives were introduced in 1997. Use of weather derivatives has quickly expanded beyond the energy industry and many experts see a wide variety of applications for these products in the future. Additionally, although they were originally confined to use in the United States, they are now freely used in many parts of Europe and Asia. Significant growth over the next few years is expected.
• Credit Securitization--Despite the rosy views of the U.S. economy, credit risks continue to be one of the most significant for many organizations. Credit securitization products were designed to hedge these risks. Typically, these products involve a portfolio of loans, bonds, or other credit assets. By bundling these assets together, they can be structured as a single portfolio with many layers, each with its own credit rating. The major advantage of these products is that bundling these risks diversifies the credit risk across single companies, industries and geographic locations, thereby becoming more attractive to the capital markets.