Alternative Risk Transfer Market - Explained
What is the Alternative Risk Transfer Market?
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Table of ContentsWhat is an Alternative Risk Transfer Market?How does the Alternative Risk Transfer (ART) Market Work? Options for Companies when choosing Alternative CarriersAlternative Risk Transfer Market OptionsOther Alternative Risk Transfer Market OptionsAcademics Research on Alternative Risk Transfer (ART) Market
What is an Alternative Risk Transfer Market?
Alternative risk transfer (ART), also known as structured insurance, is a form of coverage or protection used by risk-bearing organizations other than by conventional insurance and reinsurance. In simple terms, alternative risk transfer, or ART, is an alternative to insurance where a corporation can transfer risk without the use of a conventional form of business insurance. Its solutions are particularly useful where traditional insurance is not effective in unique and challenging situations. It provides unique ways of managing risks that are increasingly complex to businesses that can not be covered by conventional insurance and have led to increased use of the risk transfer form. The alternative market for risk transfer includes Risk Retention Groups (RRGs), insurance bins, and captive insurers.
Back To: INSURANCE & RISK MANAGEMENT
How does the Alternative Risk Transfer (ART) Market Work?
The area of alternative risk transfer grew out of a series of insurance capability crises in the 1970s through the 1990s that forced conventional coverage purchasers to search for more flexible forms of purchasing security. Across two key categories, the alternative risk transfer market is broken down into risk transfer via alternative products and risk transfer via alternative carriers. Most of these approaches enable investors in capital markets to play a more direct role in insurance and reinsurance security, thus increasing convergence between insurance and financial markets in the wider field of alternative risk transfers. The alternative market for risk management offers an organization multiple forms of policy-making options, giving it a customized existence.
Options for Companies when choosing Alternative Carriers
The main market for alternative risk transfer is self-insurance, where businesses are still government-regulated, but allowing a company to have flexibility through cost reduction and faster demand procedures. The combination of risk transfer and retention provides client security at low cost, for the benefit of both the insured and insurance companies. The following coverages are common to self-insurers:
- insurance for employees
- general liability
- vehicle liability
- physical injury
Regardless of the fact that the various States have strongly regulated compensation and automotive liability of employees, the growth of self-insurance has continued in these two sections; as cost-effective and improved risk protection are typically associated with self-insurance.
Alternative Risk Transfer Market Options
Unusual mediums used for common risk include:
- Risk Retention Groups (RRG): self-insurance (money) contributed by several small to medium-sized enterprises.
- Self-Insured Retentions (SIR): an option of setting aside the capital (money) to be used in cases of losses.
- Earnings Protection: policies available during a certain financial period through a common loss of income.
- Captives: a secondary (subsidiary) insurance company that insures only the parent company.
- Rent-a-Captives: captives exchanged by several firms that are not the parent company but the parent company manages the funds.
- Finite Insurance: multi-year policies on insurance.
- Multi-Trigger Policies: policies caused by a different timeframe by separate events.
- Integrated risk: policies covering a range of different risks (some of which are not regular insurance risks).
Other Alternative Risk Transfer Market Options
Capital market-based mediums include: Securitization: this is a procedure for combining risks into debt/equity securities that can be exchanged on financial markets. Insurance-linked bonds: this option includes bonds that completely or partially lose their principal/interest if a predicted event occurs. Contingent Surplus Notes: In this option, the notes the capital (money) supply holders when there is a loss. Weather Derivatives: policies are made available for the occurrence of certain extreme weather events in this option. Cat-E-Puts (Catastrophe Equity Put Options): this option allows a company to sell/emit equity at a fixed price in case of an event of a disaster.
Academics Research on Alternative Risk Transfer (ART) Market
- An overview of the alternative risk transfer market, Hartwig, R. P., & Wilkinson, C. (2007). An overview of the alternative risk transfer market. InHandbook of International Insurance(pp. 925-952). Springer, Boston, MA. The concept of alternative risk transfer (ART) defies a precise definition. One reason for this is that the range of risk products that can reasonably be defined as ART has expanded over time as product innovation continues. ART is not one product, but rather a way of doing business. It is generally accepted that there are two segments in the ART marketrisk transfer through alternative carriers and risk transfer through alternative products (Swiss Re 2003). The market for alternative carriers (i.e., risk-bearers) consists of self-insurance, captives, risk retention groups, and pools. Alternative products include finite risk reinsurance, runoff solutions, committed capital, multiline, multiyear products, multitrigger programs, structured finance and new asset solutions, and capital market solutions for weather risk.
- Convergence of insurance and financial markets: Hybrid and securitizedrisktransfersolutions, Cummins, J. D., & Weiss, M. A. (2009). Convergence of insurance and financial markets: Hybrid and securitized risktransfer solutions.Journal of Risk and Insurance,76(3), 493-545. One of the most significant economic developments of the past decade has been the convergence of the financial services industry, particularly the capital markets and (re)insurance sectors. Convergence has been driven by the increase in the frequency and severity of catastrophic risk, market inefficiencies created by (re)insurance underwriting cycles, advances in computing and communications technologies, the emergence of enterprise risk management, and other factors. These developments have led to the development of hybrid insurance/financial instruments that blend elements of financial contracts with traditional reinsurance as well as new financial instruments patterned on assetbacked securities, futures, and options that provide direct access to capital markets. This article provides a survey and overview of the hybrid and pure financial markets instruments and provides new information on the pricing and returns on contracts such as industry loss warranties and Cat bonds.
- Alternative Risk Transfer: The Convergence of The Insurance and Capital Markets, Kampa, C., & Siegert, P. (2010). Alternative Risk Transfer: The Convergence of The Insurance and Capital Markets. Part I, "A Broad Overview," details the evolution of Insurance-Linked Securities (ILS). Once considered to be an alternative form of risk transfer, ILS have become a mainstream method for transferring risk from insurers to the Capital markets. Parts II and II, to be released in late summer 2010, provide a micro-analysis of the non-life and life insurance-linked security sectors.
- Computing bounds on the expected payoff of alternative risk transfer products, Villegas, A. M., Medaglia, A. L., & Zuluaga, L. F. (2012). Computing bounds on the expected payoff of alternative risk transfer products.Insurance: Mathematics and Economics,51(2), 271-281. The demand for integrated risk management solutions and the need for new sources of capital have led to the development of innovative risk management products that mix the characteristics of traditional insurance and financial products. Such products, usually referred as Alternative Risk Transfer (ART) products include: (re)insurance contracts that bundle several risks under a single policy; multi-trigger products where the payment of benefits depends upon the occurrence of several events; and insurance linked securities that place insurance risks in the capital market. Pricing of these complex products usually requires tailor-made complex valuation methods that combine derivative pricing and actuarial science techniques for each product, as well as strong distributional assumptions on the ARTs underlying risk factors. We present here an alternative methodology to compute bounds on the price of ART products when there is limited information on the distribution of the underlying risk factors. In particular, we develop a general optimization-based method that computes upper and lower price bounds for different ART products using market data and possibly expert information about the underlying risk factors. These bounds are useful when the structure of the product is too complex to develop analytical or simulation valuation methods, or when the scarcity of data makes it difficult to make strong distributional assumptions on the risk factors. We illustrate our results by computing bounds on the price of a floating retention insurance contract, and a catastrophe equity put (CatEPut) option.
- Alternative Risk Transfer, Culp, C. L. (2005). Alternative Risk Transfer. InRisk Management(pp. 369-390). Springer, Berlin, Heidelberg. Alternative risk transfer (ART) refers to the products and solutions that represent the convergence or integration of capital markets and traditional insurance. The increasingly diverse set of offerings in the ART world has broadened the range of solutions available to corporate risk managers for controlling undesired risks, increased competition amongst providers of risk transfer products and services, and heightened awareness by corporate treasurers about the fundamental relations between corporation finance and risk management. This chapter summarizes the dominant products and solutions that comprise the ART world today.