Alternative Risk ApproachesPresented by
David Kalainoff, Vice PresidentTransatlantic Reinsurance Company
Seamus Tivnan, Senior Vice PresidentMarsh Management Services (Cayman), Ltd.
Philip Reischman, Executive Vice PresidentGallagher Healthcare Insurance Services
Medical Professional Liability SymposiumMarch 21 – 22, 2002
Chicago, IL
Alternative Risk DefinedAlternative Risk Defined
Alternative (adj.):offering a choice of two or
more things; offering a second thing or proposition
1
Risk (n.):the chance of loss; the degree of probability of loss
Source: Webster’s Third World International Dictionary (unabridged)
Alternative Risk DefinedAlternative Risk Defined
Alternative Risk (n.):the option for an Insured to pay a
lot of premium for limited coverage under a Contract of Insurance or Reinsurance that no one understands, but for which the Broker receives a stout commission!
Source: The Cynical Brokers’ Dictionary2
Characteristics of Alternative Risk ProgramsCharacteristics of Alternative Risk Programs
Loss Sensitive
Finite (Aggregate) Limit
Significant Rate On Line
Investment Income Recognition
Prospective Or Retrospective
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Re-Emergence Of Alternative Risk ProgramsRe-Emergence Of Alternative Risk Programs
Massive Premium Increases
Retention Increases
Desire For Frequency Protection
Desire For Long-Term Stability
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Escalating migration of premium into ART market (1997-2002)
0
10
20
30
40
50
60
70
80
90
1997* 1998* 1999* 2000* 2001* 2002*
% o
f mar
ket
-5
0
5
10
15
20
25
30
35
40
Ann
ual p
rem
ium
gro
wth
US Commercial Market Global Alternative Market
US Commercial Market Annual Premium Growth Global Alternative Market Annual Premium Growth
Business Moves To ARTBusiness Moves To ART
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Types Of Alternative Risk VehiclesTypes Of Alternative Risk Vehicles
Direct Insurance
Captive Vehicles
Risk Retention Groups
Reinsurance
Capital Market Structures
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A good forecaster is not smarter than everyone else…he merely has his ignorance
better organized
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Deep ThoughtsDeep Thoughts
A Captptive………..………..
Take Prisoner
Keep On Confinement Or Under Restraint
Unable To Escape
Source: Oxford English Reference Dictionary - 2nd Edition
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What Is A Captive………..What Is A Captive………..
Licensed Insurance Company
Formed To Insure Or Reinsure The Risk Of Its Owners Or Unrelated Parties Of Their Choosing
Regulated Under Special Legislation
Located Offshore Or Onshore
Admitted Only In Its Domicile And Non-Admitted In All Other Jurisdictions
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Captive Vehicles - Single ParentCaptive Vehicles - Single Parent
A Licensed Insurance Company Primarily Designed To Insure The Risks Of The Parent
Generally One Shareholder And ‘One’ Insured
Migrated To Multiple Insured
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Captive Vehicles - Group / AssociationCaptive Vehicles - Group / Association
Stock Or Mutual Or ‘Single Parent’
Homogeneous Or Heterogeneous
Multi Line
Fully Pooled, Layering Of Losses And Sharing By Participants Within Layers
Aggregate Limits, Securitization Of Gaps
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Captive Vehicles – Rent-a-Captive / Cell TypeCaptive Vehicles – Rent-a-Captive / Cell Type
R-a-C - ‘Pooled’ Resources, But Separate Fully Collateralized Programs
Access To ART Market Without The Capital Outlay, Administration
Segregated Portfolio / Protected Cell
‘Legalized’ R-a-C
Tax Deductibility Issues• Pooling / Sharing Within Cells
Biggest Concern - New Untested Legislation13
IRS Tax Deductibility TestIRS Tax Deductibility Test
Existence Of Risk Transfer
Presence Of Risk Distribution
Case Law Matching
Unrelated Premium Or ‘Single Parent’
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Captive Vehicles - Why?Captive Vehicles - Why?
Traditional• Cash Flow, Reduced Costs, Direct
Reinsurance Placement
Recent• No Option - Cannot Afford Or Cannot
Find
Control Own Destiny
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Captive Vehicles - How?Captive Vehicles - How?
Feasibility• 3 - 6 Months, c. $25k
Implementation• 1 - 3 Months, From $15k
Capitalization• From $120k
Administration• From $75k
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A novice uses statistics like a drunkard uses a lamppost…for
support, not illumination
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Deep ThoughtsDeep Thoughts
Captive Vehicles - Where?Captive Vehicles - Where?
Basically Anywhere
Onshore• Vermont• Hawaii
Offshore• Bermuda
Cayman• 550, 47 New In 2001, 70 Plus In 2002?
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Captive Domiciles - What to Look For?Captive Domiciles - What to Look For?
Accessibility
Flexibility
Stability
Infrastructure• Physical• Professional• Legislative
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Go Off-Shore - “Less Regulation”Go Off-Shore - “Less Regulation”
Cayman Islands• Removed From FATF Blacklist• IMF Visit• Tax Treaty• Regulator
– Autonomous– Enforcement Powers– On Site Inspections
Know Your Customer
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Healthcare Captive Vehicles - Where?Healthcare Captive Vehicles - Where?
Cayman Islands
Healthcare Captive Capital
Harvard Group Started And All Followed
180 Healthcare Related Captives
One In Three Of The Market
$800m In Premium
$4B In Assets21
Risk Retention GroupsRisk Retention Groups
All Insureds Are Members (Owners)
Single State Domicile
Registration In 49 States
Can Eliminate Need For Fronting
Subject To NAIC Reporting Requirements
Higher Capitalization Requirements
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Alternative Risk Finance Captive OptionAlternative Risk Finance Captive Option
Advantages• Long-Term Solution• Generate Investment
Income• Benefit From
Experience• Tax Advantages• Access Reinsurance• Control Of Destiny• Executive Focus
Disadvantages• Assumption Of Risk• Costs To Form And
Operate• Internal Costs• Restricted Capital• Fronting Challenges
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Captive OptionCaptive OptionRole of Primary CarrierRole of Primary Carrier
Fronting Vehicle
Claims Management
Underwriting / Actuarial Report
Excess Of Loss Or Quota Share
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Captive OptionCaptive OptionRole Of ReinsurersRole Of Reinsurers
Underwriting and Actuarial Support
Excess Of Loss And Quota Share
Loss Portfolio Transfers
Capacity Support
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Goal: Achieve Efficient Frontier Of Risk Retention / Risk Transfer For Mutual Benefit Of Buyers And Underwriters
Excess Alternative Risk StructuresExcess Alternative Risk Structures
Types Of Structures
Annual Aggregate Deductibles (AAD) Buffer Layers Commutation Options Co-Insurance Swing Rating Plans No Insurance
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Example:Current Retention = $5 Million Each And EveryRenewal Retention = $10 Million Each And Every
Annual Aggregate DeductibleAnnual Aggregate Deductible
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Comments: Insured Has Protection For Frequency Of Severe
Losses Insurer / Reinsurer Gets Larger Risk Margin Works Better On Excess Layer
AAD Approach:Renewal Retention = $5 MillionAnnual Aggregate Deductible = $5 To $10 Million
Example:Current Retention = $2 Million Each And EveryRenewal Retention = $5 Million Each And Every
Buffer LayerBuffer Layer
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Buffer Approach:Renewal Retention = $3 Million Each LossFirst Excess Layer = $2 Million Per Loss / $4 Million
Agg.Comments: Insured Maintains Comfortable Retention Level Insurer / Reinsurer Collects Premium At Significant Rate
On Line And Losses Are Capped Traditional Excess Attaches Above Buffer Layer May Be Enhanced With Commutation Option
Example:Insured Has Option To Commute Coverage And Assume The Previous Insured / Reinsured Risk Retrospectively
Commutation OptionsCommutation Options
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Formula:Gross Written Premium
– Expense Component– Risk Margin+ Accumulated Investment Income= Experience Account
Commute At:24 Mos. Post Expiration = 100% Of Experience Account36 Mos. Post Expiration = 75% of Experience Account48 Mos. Post Expiration = 50% of Experience AccountAfter 48 Mos. = Option Lost
Comments: Works Better On Working Layers Or On First
Excess Layers
Insured Has Retrospective Look At Losses Before Assuming Higher Retention
Contract Documentation Is Critical
Insured Solvency Is Important
Initial Premium Is Higher Than Similar Deal Without Commutation
Commutation OptionsCommutation Options
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Other ApproachesOther Approaches
Swing Rates
Co-Insurance
Indexing
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Comments: Designed To Protect Underwriter, But Give
Benefit Of Favorable Experience To Insureds Work Best In Working Layers All Are Re-emerging As Rates Increase
The “No Insurance” OptionThe “No Insurance” Option
Formal Self Insurance Vehicle• Captive• Trust
Prudent Funding Level• Actuarially Developed• Limits Consistent With Balance Sheet
And Industry
Modified Negotiation Postures• No Insurance• Community Support
34
The statistics on sanity are that one out of every four Americans is
suffering from some form of mental illness. Think of your
three best friends. If they’re okay, then it’s you.
35
Deep ThoughtsDeep Thoughts
Material Underwriting IssuesMaterial Underwriting Issues
Insured / Reinsured Funding Levels
Claims Management
Loss Control / Risk Management
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Alternative Risk StructuresAlternative Risk StructuresThe FutureThe Future
Clearly Market Driven And Utilization Will Increase
Preserves Premium (And Hopefully Underwriting Profit) For Commercial Insurers / Reinsurers
Downward Bias In Retention Levels And Risk Margins As Market Softens
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Statistics are like bikinis…what they reveal is suggestive, but what they conceal is vital.
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Deep ThoughtsDeep Thoughts