What is Alternative Risk Transfer?

Insurance or reinsurance provided by an insurer or reinsurer licensed or authorized in the jurisdiction in question. This means the company complies with the jurisdiction’s regulations.

Alternative Risk Transfer or ART is used to describe a broad range of risk transfer, risk financing and retention solutions that do not fit the conventional Property and Casualty insurance model. There is no set definition of what ART consists of, but it is often used as a ‘problem solving’ approach for key business concerns.

ART solutions include parametric, captive solutions, capital solutions, retention financing or structured re/insurance. ART is growing in popularity as multinationals evolve their risk management strategies and seek bespoke solutions for an increasing array of risk scenarios that are not always catered for by the traditional market.

A country, territory or state that licenses a captive insurance company and has regulatory oversight over it. Bermuda was the initial center for captives. Today, it is estimated that more than 70 jurisdictions around the world have some form of captive legislation.

A large, multinational company with its own captive program can still benefit from services from insurance companies. Typically, captives may not have the capital, regulatory permissions for insurance transactions around the world or other infrastructure that an insurer can offer.

For this reason, they often utilize fronting services, whereby insurers take on the operational work of issuing and managing the policies and premium payments. Additional services and solutions such as claims, risk consulting, underwriting, or structured reinsurance programs can also be provided.

A bona fide licensed (re)insurance company that is set up and managed in order to serve the insurance needs of its parent company, giving it greater control over coverage, claims and risk financing. It is a formalized mechanism to finance self-insured risks that can be tailormade to a business’ requirements. A captive can buffer its owner against the fluctuations in cost and capacity constraints of the traditional insurance market and potentially offer underwriting profits in the case of a good claims record. Captives are usually established by larger businesses that face specific risks or regulatory challenges. 

Catastrophe bonds, or cat bonds, are multi-year collateralized  covers for named natural catastrophes such as storms and earthquakes, using an indexed loss trigger. They are an example of insurance securitization transferring a specific set of risks to capital market investors. Bermuda remains by far the largest issuer domicile of catastrophe bonds or other forms of insurance-linked securities.

Investors take on the risk of a catastrophe loss in return for rates of investment return. Should the named peril event occur, the pay-out will be triggered automatically, and the investor will lose some, or all, of the capital they have invested. An insurer or reinsurer is typically involved as ‘issuer’ of bonds and will receive the money to cover claims. 

Financial instruments which transfer a specific set of risks, typically natural disaster perils, from an insurer to investors or other insurers utilizing triggers with defined parameters. In the case of a financial cat swap, the insurer pays a third party to assume the financial risk of a defined event such as a Florida hurricane in exchange for a payment(s). If the event occurs and meets the pre-defined trigger criteria, the third party is responsible for the pre-agreed financial risk.

Cell captives, also known as protected cell companies or segregated cell insurers, are used to enable individual companies to access reinsurance market capacity. Companies without their own captive insurance program can enter ‘rent-a-captive agreements’ with the operator of a cell captive which maintains standalone underwriting accounts for each participating organization. Cell captives are typically set up and managed by brokers.

Using a licensed, admitted insurer to issue an insurance policy on behalf of a self-insured organization or captive insurer. The fronting company is an entity licensed to operate in the region of interest and it may or may not retain a portion of the risk. A fronting fee is charged, typically representing a percentage of the total premium placement facilitated.

Insurance-linked securities (ILS) offer insurance and reinsurance companies a means of transferring a portion of their risk to the capital markets. They are derivative or securities instruments whose performance depends upon the occurrence of pre-defined catastrophic events. Catastrophe bonds (‘cat bonds’), which insure against natural disasters, are one of the most common types of ILS.

Insurance companies not licensed in a particular jurisdiction may conduct business in that jurisdiction if an admitted insurer issues the policy and reinsures losses to the non-admitted carrier. A captive is an example of an unlicensed, non-admitted insurer except in its own domicile. 

Reinsurance purchased from a carrier which is not licensed or authorized to transact in a particular location. This may not be treated as an asset against reinsured losses or unearned premium reserves for insurance company accounting and statement purposes.

Parametric insurance triggers a pre-agreed pay-out to a policyholder in the case of a pre-defined event or threshold being reached, rather than indemnifying an actual loss. It can insure against risks for which no traditional insurance product is available, or where the exact loss to a client is difficult to establish. Example triggers can range from extreme weather events impacting crop yields, lack of wind or sun affecting renewable energy companies, or low river water levels disrupting supply chain logistics.

Retention is the retained financial risk a company or – in case of a reinsurance cession – the reinsurer keeps for its own account. Losses can be retained by means of non-insurance, self-insurance, or deductibles. Retention can be intentional in the sense of a risk-sharing approach for mutual benefits, or it can be unintentional, when exposures that have not been identified materialize as losses.

A risk management strategy where a company creates a vehicle such as a captive to retain, manage and mitigate its risks rather than buying coverage from traditional insurance markets.

Stop loss cover reinsures the captive’s retention for losses over and above a set annual or term aggregate, up to the limit of liability. These can be primary or excess retentions, or a combination of both. They can also be multi-line combined aggregates or mono-line. 

Structured (re-)insurance solutions are bespoke solutions to individual client requirements. They are typically multi-year and/or multi-line coverage solutions that combine various property or liability covers under one contractual wording, providing a better diversification of risk. The insured company retains a significant amount of the primary risks and is rewarded for good claims performance, while the (re-) insurer provides risk transfer elements in the event of multiple catastrophic events or unforeseen high frequency of losses, either in one year or accumulated over a multi-year period. Structured (re-) insurance protects the corporate from being over-exposed to sideways risk, provides contract certainty and budgetary stability and reduces capital requirements for the captive. 

A multi-year insurance program that shares some of the elements of a captive but leaves a portion of the risk (the retention) on the policyholder’s balance sheet. It does not involve the same level of equity capital or regulatory complexity as a traditional captive. The company pays an annual premium to provide for the risk of owning claims with a bonus-malus system. The contract is renewed for a further year if the cumulative loss ratio does not exceed an aggregated level; if it does, negotiations between the parties are required to adjust the terms or the contract is terminated.