On Aon Podcast: Another Way of Looking at Risk: Alternative Risk Transfer

On Aon Podcast: Another Way of Looking at Risk: Alternative Risk Transfer
July 25, 2024 15 mins

On Aon Podcast: Another Way of Looking at Risk: Alternative Risk Transfer

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Episode 77: Aon experts discuss the ins and outs of alternative risk transfer (ART).

Key Takeaways
  1. In this episode, Aon experts identify the benefits of parametrics for clients and the wider market.
  2. Aon’s experts share the value of ART solutions in the changing marketplace.
  3. Episode 77 provides insights on the evolution of market conditions in the casualty space.

Intro:
Hi everyone, and welcome to the award-winning “On Aon” podcast, where we dive into some of the most pressing topics that businesses and organizations around the world are facing. Today we hear from Rob Kemp and Guy Malyon on alternative risk transfer. Now, please welcome this episode’s host, Natalia Svirschevsky.

Natalia Svirshchevsky:
My name is Natalia Svirshchevsky and I'm head of strategy and program management for EMEAs commercial risk business. In today's On Aon episode, we're going to be looking at alternative risk transfer or how we like to call it ART. Put simply, ART is the use of alternative techniques to achieve the same hedging and transfer risk as with traditional insurance or reinsurance to help clients protect themselves. Specifically for more complex risks, ART becomes important in providing flexible and bespoke solutions to meet client needs. With me today, we have Rob Kemp, strategic broking director, property for Aon EMEA, and Guy Malyon strategic broking director casualty for Aon EMEA. Thank you both for being here today.

Rob Kemp:
No problem. Thanks for having us.

Guy Malyon:
Yeah, thanks Nat.

Natalia Svirshchevsky:
In our discussion, we're going to walk through several questions. What does today's market look like? How does ART help clients manage today's risk and do parametrics offer even more opportunities? So, let's get started. Rob, maybe I'll start with you. So how would you describe the market today? So given the current shifting dynamics, how are they changing or how have they changed the conversations that you're having with some of your clients?

Rob Kemp:
Well, I think we've been through a pretty challenging period in the market. We've seen insurers looking for rating adequacy, managing their exposures. We've seen some quite significant terms and conditions being imposed on many of our clients, and that's been particularly hardly felt for those clients with high hazard occupancies, natural catastrophe exposures or impacted by claims. And if we look at the past year, just from a property perspective, global NACA losses were around about $118 billion, way above the historical averages.

So, I think in that context, the market has been very difficult for the past few years. I think that the positive news is it's beginning to transition. So, I'd like to call it the kind of transitioning marketplace where we are seeing conditions start to moderate. We saw a treaty renewal season in 2024, which was more stable and orderly than it has been historically, and a fairly equal balance between supply and demand.

So that was positive. So definitely seeing the market make a transition. I guess what we have seen off the back of that is many organizations start to re-look at their risk financing strategies, reassess their risk appetites, look at how they use their own risk capital and how they use the insurance market capital as well. And I know Guy and I, when we're talking to clients and prospects, a lot of the questions we get would be things like, how do we optimize our total cost of risk? How do we manage the volatility within our captives? The market has asked us to take more risks so there's more volatility. How do we manage that? And then how do we look at securing capacity over the longer term, which I think leads us very neatly to better budgeting, more stability, greater certainty of cover and pricing. So I think the market is definitely transitioning. It's improving, but it is provoking more conversations around different ways of managing risk and managing that volatility.

Natalia Svirshchevsky:
Yeah, that's quite interesting from a property perspective. And Guy, how about you? How would you say that the market conditions are changing in the casualty space?

Guy Maylon:
They haven't changed for the last year or so, and I think there'll be more of the same this year, but I really describe it as a bipolar market. On the whole, it's a very competitive market. There's plenty of options out there. There's plenty of capacity, there's growth targets with insurers. They want to write new business, but there's a big bump. And the blot is, any clients that have significant U.S. exposures or revenues or those as Rob's mentioned, high hazard occupies, and in the casualty world, that could be pharmaceutical, chemical mining, auto part manufacturers. And so, those companies with U.S. or in those high hazard industries are still seeing increases, still seeing compression in terms of conditions, and particularly capacity and don't see that changing too much this year.

Natalia Svirshchevsky:
Thanks for that, and it's quite interesting to hear that from both of you. As we hear more from clients trying to find new solutions to the changing marketplace or changing challenges that they face. Now, if we bring an alternative risk transfer, for those who are not familiar with it or do not know what it is, can you explain the concept and specifically why some clients should consider it? Guy, do you want to kick us off?

Guy Malyon:
Yeah, so ART can mean different things to different people. It could range from just setting up a captive or a sale or it could go towards a fully multi-year, multi-line structure solution. And there's many things in between. But I think Rob's already mentioned, I think in any conversation we have with clients, there's probably two topics that really determine whether ART is suitable. And it's one where a client really wants to manage the total cost of risk, and two, as Rob said, manage volatility over a period of time.

So, if I go back to the hard market, the start of the decade, this led a lot of clients to question I think the relevancy, more importantly the reliability of the conventional insurance market. But let's be honest, there are countless examples, millions of examples over 500 years, the insurance market, conventional market's been in place where the insurance market has helped clients. But increasingly, risk managers and more importantly the finance teams or the finance management within the clients – and probably the larger clients – has shown a lot of interest in something different, something new alternative to conventional market, looking at different ways of doing things more sustainable, more stable, longer term solutions whereby they can really back their risk management and potentially share any upside as well as potentially share any downside.

So, we recently showcased such a solution with one of my clients at the recent Aon insight series in London whereby we replaced a five-year non-cancelable nonadjustable structured insurance program. So, we're not talking about theory here, we're actually placing these deals. And quite often they involve long-term capacity, so stretching aggregate capacity over a period of time. And the client will fund the first loss and then the second loss will be taken by the insurers, or a second or third loss will be taken by the insurers. So, it is a different way of placing business on an annual basis and all the paying that goes through with the annual renewal process. But as I said, more importantly, and I think Rob referenced this earlier, it allows clients to budget more effectively and plan for the longer term because they know what a worst case scenario is going to be.

Rob Kemp:
I agree with all of that, Guy. I think when we talk about ART, what we're really talking about is how do we bring the full breadth of capital resources to our clients. So, when they've got challenging complex needs, we want to make sure we're accessing the full spectrum of the insurance market, both traditional and non-traditional so that when insurers have their budget spend for the year, we have made full use of the marketplace that's available.

So, when we look at ART, I mean as Guy mentioned, structured deals, whether it's simple capital solutions, multi-year, multi-line stock loss, it can be fronting deals, it can even involve cap bonds and insurance-linked securities as well. So, there's a whole raft of capital out there which falls within that ART space.

But fundamentally what we are trying to achieve is make sure that all of that risk capital is brought to our clients to give them the flexibility in what has been a challenging marketplace, but more importantly to set them up for years to come so that they become more resilient to the marketplace and flexibility and changes within it.

Natalia Svirshchevsky:
And you mentioned the need for clients when it comes to perhaps some of those longer tail risks. Are you seeing that there are certain client industries or client types that are bringing more and more of ART into their overall risk portfolio? How are you seeing that?

Guy Malyon:
We're seeing it across all range of industries, all sizes. It's going to be the larger clients on the whole, I think every client has a different motivation. The client that I placed the deal for was, it was all about managing volatility within his captive results. You've got another client I'm working with where they just want stable premiums over the longer term so they can then plan going forward.

You've got other clients whereby they're paying a huge amount annually to the market. So, we're saying, look, there is another way. So, I haven't yet found a line of business that wouldn't be applicable to ART. And it's really a numbers game and it's making sure the numbers work, but even then, if the numbers aren't quite there, the client might have a different motivation. But Rob, what do you think?

Rob Kemp:
Well, and I think every deal is bespoke to each client. So, there's no one size that fits all when we're looking at solutions for the clients, and every client has a slightly different motivator. I don't think there is any single one industry or sector which is more suited. And I think client needs dictate the type of solutions, whether it's structured, whether it's fronting solutions, whether it's looking at parametrics and natural catastrophe cover. So, I think every client is different. Every driver behind exploring ART can be different and these deals are bespoke.

Natalia Svirshchevsky:
And you mentioned something that we are starting to hear more and more of, and it's the topic of parametric, especially when it comes to ART. So how would you describe parametric? Given that it's relatively, I know it's been going on for a number of years, but relatively newer into the breadth of ART. What would you say are some of the benefits? How are you seeing the appetite for parametrics develop amongst both clients and the wider market?

Rob Kemp:
So, if we think about traditional insurance, it operates on the basis of indemnity. So, an insured event happens, the actual loss dictates the claim settlement that is paid out. For parametric insurance it works on a different basis where a pre-agreed physical parameter is triggered, and the payout is based on a predetermined payout table. So, for example, if we're talking about hurricane, it would typically be wind speed. If we're talking about earthquake, it would be shake or intensity. The hail size. Water level, if we're talking about rivers. So effectively the event occurs, the third party index is verified, and the claim is paid and then the loss is confirmed. So, we like to call it an “if-then” situation. So if an event happens, then cover is paid, or the claim is paid. And I think why clients are looking at it is really three things.

The first is the speed of payment. So, a parametric insurance program pays out very quickly. There isn't the loss adjusting process that there is in a normal traditional program. So, there is very quick liquidity in the event of a disruptive event happening. And that can be weeks rather than months or even years for a payout to happen. So very quick access to funds.

The second would be broad cover. So, payment can be used for any financial loss resulting from the event. So, it can often include losses that typically would be excluded from traditional insurance programs. So, a lot of flexibility around the cover for clients. And then there's the flexibility of design. So, these solutions are designed to be customized to solve specific problems that are either difficult to place in the traditional marketplace or indeed are absent from the traditional marketplace. So, I think those are the three motivators behind parametrics.

Historically, they've been focused on natural catastrophe exposures. So, as I mentioned before, hurricanes, earthquakes, water levels, wildfire, hail, drought events. So easily determined events where there are independent third party indexes. I think where the market's beginning to go, and I say beginning, but certainly where I think clients are looking for it to go is for some of those non-natural catastrophe events. So things like, for example, cyber cloud outage, some non-damaged BI type scenarios as well. So, I think the market is starting to move in that direction. It's certainly where clients are looking to get more help. And I guess as we look at some of the future risks and we look at things like energy transition, I think parametrics have a really important role to play in helping our clients prepare for that changing risk environment as we move forward.

Natalia Svirshchevsky:
Guy, any points from your perspective on the casualty side when it comes to parametric?

Guy Malyon:
Not necessarily. We are talking about how we could apply parametric techniques to wildfire exposures on the liability side? Which is very pertinent to power companies. Yet to be tested, but it's something we're talking about. But I think just one thing I'm going to just add to what Rob said, the client that I deal with regularly is a closed retailer and just set up two new stores in Florida. And the client said to me, "Look, I don't really need full business interruption cover. What I need is access to quick cash to be able to sell clothes following the hurricanes." And people have just lost everything in the hurricane. And that's something that we're exploring at the moment. I think it's just another example where this isn't deemed a replacement for the recovery already has, but it's more an addition.

Rob Kemp:
Guy, that's a really good point because I think historically parametric insurance has been seen to replace traditional insurance or to compete with traditional insurance. I think actually how it should be seen, and I know many of our clients look at it this way, exactly the right way, which is it's a complimentary insurance to traditional. So, it can be used in a different way, whether it's to provide liquidity, whether it's to look at single locations, sometimes to support deductible structures and strategies, but it's a complimentary insurance to cover that can be provided under traditional insurance. And I think where we're seeing more and more buy-in from clients and more parametric deals being bound is where it is a complimentary form of cover.

Natalia Svirshchevsky:
Thank you both so much. I think that was a great overview in terms of helping us understand what the market looks like, how ART is helping clients manage today's risk, and specifically the role of parametrics and increasing role of parametrics and appetite to look at some of those opportunities. So thank you guys again for joining. That's our show for today. Thank you all for listening. In the next few months, we'll be discussing more risk capital and human capital topics. So, until next time.

Outro:
Thanks for tuning in to the latest episode of “On Aon” with our episode host, Natalia Svirschevsky, and today’s experts, Rob Kemp and Guy Malyon, for a discussion on alternative risk transfer. If you enjoyed this episode, don’t forget to subscribe wherever you get your podcasts, and stay tuned for our next conversation featuring industry experts bringing you the latest on topics, including climate risk, workforce wellbeing, ESG trends, and much more. Be sure to check out our show notes and visit our website at Aon dot com to learn more about Aon.

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