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RESEARCH AND BRIEFINGS

Webcast: Alternative Risk Financing Strategies

 


Some organizations already use alternative risk financing strategies, but others have yet to include them as part of their risk and insurance programs, according to panelists on Marsh’s New Reality of Risk® webcast. 

An alternative risk financing strategy views insurance as a source of capital that can be used to help manage and mitigate volatility in the context of other available capital sources. As data and analytics in risk financing have made risk retention decisions easier to assess and quantify, some companies have turned to alternative capital and captive insurance companies to finance particular risks. These evolutions have created alternatives to — but not supplanted — the “traditional” approach of purchasing a standard commercial insurance policy. 

“Ultimately, insurance is a good source of capital and it shouldn’t be dismissed,” said John Davies, managing director of Marsh’s Risk Finance Practice. “Rather, it should be blended with other sources of capital — that’s what the ‘alternative’ is.” 

Only 38% of respondents said they use alternative risk finance as part of their risk finance programs. This may underscore organizations’ lack of understanding of their risk appetite and/or risk tolerance. According to respondents, more than half said that they do not, or are not sure, if their organization has developed formal enterprise-level risk appetite and/or risk tolerance statements. 

To determine whether to use alternative capital such as insurance-linked securities, which include catastrophe (CAT) bonds, organizations first need to understand the underlying volatility of a particular risk. Such an understanding — defined by frequency of losses and severity — can help companies consider the potential benefits. 

“It is important to understand that alternative capital is a critical part of risk financing strategy because organizations can access a deeper pool of capital to transfer their risks,” said Greg Hagood, managing principal at Nephila Advisors LLC. For organizations, this does not mean that all their exposures need to be funded through alternative capital. “But a component of their risks that happens to be more volatile and therefore more expensive to transfer via insurers should go to a marketplace with a bigger pool of capital where it will likely be financed for less money,” Mr. Hagood said. 

Companies determining the use alternative risk financing are also considering captive insurance. “We’re seeing a growing trend among companies looking at captives,” said Ellyn Casazza, senior vice president of Marsh Captives Solutions. 

Captives can help its parent company achieve financial objectives, access capital, support business units, and fund employee benefit plans. “At the core, captives are helping achieve financial objectives — as far as a value proposition, it provides a cost savings,” Ms. Casazza said. 

Midsize organizations with significant casualty risks — such as workers compensation, general liability, and auto liability — are increasingly considering group captives as an alternative risk financing strategy, said Geoff Welsher, managing director of Marsh’s Group Captives Practice. A group captive is owned by participating non-related members, primarily to insure or reinsurer their casualty risks. 

Although companies may share some risk with other captive members, the premiums in a group captive are calculated and based largely on the individual member company’s loss costs and loss control efforts. “As a result, members often see more efficient and stable insurance pricing over time, especially when improved loss control efforts reduce loss frequency,” Mr. Welsher said. 

Listen to the webcast replay.