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STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM...

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STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM Managing Director ARM Tech, an Aon Company Presented by: Jenny P. Emery Senior Vice President Towers Perrin Reinsurance
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Page 1: STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM Managing Director ARM Tech, an Aon Company Presented by:

STRIMA

September 18, 2002Branson, Missouri

Alternative Risk Financing

Steven P. Kahn, CPCU, ARM

Managing Director

ARM Tech, an Aon Company

Presented by:

Jenny P. Emery

Senior Vice President

Towers Perrin Reinsurance

Page 2: STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM Managing Director ARM Tech, an Aon Company Presented by:

A Definition

Alternative risk financing refers to loss funding mechanisms other than commercial insurance.

Exhibit 1

Page 3: STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM Managing Director ARM Tech, an Aon Company Presented by:

Key Point

Closely evaluate:• Real risk financing needs

• “Hazard” risks and other risks

• All costs of the mechanism

• Financial, political and legal support you will need

Exhibit 2

Page 4: STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM Managing Director ARM Tech, an Aon Company Presented by:

Loss Portfolio Transfer

In return for a premium payment, an insurance company assumes responsibility for incurred but unpaid claims.

Exhibit 3

Page 5: STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM Managing Director ARM Tech, an Aon Company Presented by:

Advantages of LPT

1. Establishes a defined level of certainty for future loss payments (up to the policy limits).

2. Insurer is responsible for:• Loss development• IBNR

3. Removes what is often an unfunded liability.

4. May place claims administration responsibility with another organization.

Exhibit 4

Page 6: STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM Managing Director ARM Tech, an Aon Company Presented by:

Key LPT Issues1. Limits:

• Size of each claim insurer will pay• Aggregate amount insurer will pay

2. Scope of coverage within which claims fall.3. Allocated loss adjustment expenses:

• Insurer pays all ALAE• Insurer pays pro rata share of ALAE• Insurer pays no ALAE

4. Data needs:• Actuarial study:

— Loss projection— Payout pattern

• Claims audit• Discount factor you want to use

5. Data credibility.

Exhibit 5

Page 7: STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM Managing Director ARM Tech, an Aon Company Presented by:

Finite Risk Insurance

A program in which the insured pays a premium to the insurer based on the losses the insured can expect to pay.

The insurer will pay losses within set limits and credits interest earnings to the insured.

Exhibit 6

Page 8: STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM Managing Director ARM Tech, an Aon Company Presented by:

Typical Features of Finite Risk Insurance

• Multi-year policy• Insurer has interest rate risk but seeks to

limit this• Insurer has timing risk• Insurer profit is based on fees and use of

funds• Insured has a credit risk• Insured may receive a premium return if

losses are less than expected• Can apply to uninsurable risk

Exhibit 7

Page 9: STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM Managing Director ARM Tech, an Aon Company Presented by:

Catastrophe Bonds

1. State issues bonds2. If the specified type of loss occurs:

a. Interest is forgivenb. Interest and principal are forgiven

3. Specified losses:a. Earthquake b. Windc. Flood

All exceeding certain size and damage4. A few specifics:

a. Principal put in trustb. Period interest paymentsc. Principal repaid at maturity

Exhibit 8

Page 10: STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM Managing Director ARM Tech, an Aon Company Presented by:

What is a “Pool”

A group of entities that:– Jointly retain losses to a selected level– Arranges services needed to support the

program

Exhibit 9

Page 11: STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM Managing Director ARM Tech, an Aon Company Presented by:

Alternative Forms

1. Trust

2. Risk retention group

3. Group/association captive

4. Joint powers authority

5. Licensed insurer

Exhibit 10

Page 12: STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM Managing Director ARM Tech, an Aon Company Presented by:

Typical Pool Structure

Exhibit 11

Individual Members

Excess Insurance

Pool Retention(Loss Fund)

Loss Payments

Premiums

Services:•Legal defense•Claims administration•Other

Page 13: STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM Managing Director ARM Tech, an Aon Company Presented by:

Advantages of Pools

1. Reduce cost2. Stabilize cost3. Customized rating plan4. Directed loss control5. High-quality claims service6. High-quality administration7. Broad coverage8. Build long-term equity

Exhibit 12

Page 14: STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM Managing Director ARM Tech, an Aon Company Presented by:

Potential Disadvantages of Pools

1. Less flexibility

2. Management time

3. Underfunding

4. Industry-specific loss problems

Exhibit 13

Page 15: STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM Managing Director ARM Tech, an Aon Company Presented by:

Key Issues1. Rating plan that:

• Provides savings to all• Does not result in adverse selection

2. Use of agents

3. Building surplus vs. keeping rates low

4. Sufficient administrative support:• Staffing• Other expenditures

5. “Political” issues

Exhibit 14

Page 16: STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM Managing Director ARM Tech, an Aon Company Presented by:
Page 17: STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM Managing Director ARM Tech, an Aon Company Presented by:

Challenges You Have Tackled

• Managing and reducing risk created by state operations

• Optimizing use of commercial insurance

• Measuring and managing risk financing costs for budgetary stability

• Deriving real value from service providers

Exhibit 15

Page 18: STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM Managing Director ARM Tech, an Aon Company Presented by:

Ideas for Challenges You Should Tackle Next

1. The risk you pay for….indirectly

2. The unreasonable penalties the excess market wants you to pay

3. The de-stabilizing risks that the insurance industry isn’t very good at

Exhibit 16

Page 19: STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM Managing Director ARM Tech, an Aon Company Presented by:

Sources of Indirect Risk

• “Cost Plus” contracts:– One-time (e.g., construction)– On-going (e.g., outsourced services)

• State-funded services that require minimum insurance:– Social service agencies

Exhibit 17

Page 20: STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM Managing Director ARM Tech, an Aon Company Presented by:

Example Success Story: Public Sector Transportation

Before

• Six contracted bus companies spending $15 million/year on auto liability

• Poor services; no incentive to manage risk

• Cost passed-through to DOT

After

• DOT-sponsored insurance program:– Large SIR’s

– High limits

– Quality coverage and service

– Incentives to improve risk management

• All-in program cost: $11.5 million/year

Annual Savings: 23%

Exhibit 18

Page 21: STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM Managing Director ARM Tech, an Aon Company Presented by:

Unreasonable Penaltiesin the Excess Market

• Sources of trouble:– Years of underpricing– Emerging exposures (asbestos, mold)– 9/11– Investment losses

• Impact on buyer of excess:– Expanded definition of “working layer excess”– “Exorbitant” cost for truly remote protection

Exhibit 19

“If the risk is really so remote that I shouldn’t charge much for it, then it’s not worth writing it. I have to charge with the expectation that a loss will occur.”

— U.S. Reinsurance Executive

Page 22: STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM Managing Director ARM Tech, an Aon Company Presented by:

Example Success Story:NLC Mutual Reinsurance

Before

• Numerous state-municipal league-sponsored pools buying excess

• Typical costs 10% to 25% of premium dollar

• Little negotiating power

After

• NLC Mutual negotiating Reinsurance Treaty on behalf of many pools

• More capacity; better pricing

• Dividends returned to member

Result: 18.86% of PremiumReturned to Members over past 8

yearsExhibit 20

Page 23: STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM Managing Director ARM Tech, an Aon Company Presented by:

The De-stabilizing Risks

• Terrorism

• Newly emerging (e.g., mold)

• Industry-specific risks

Exhibit 21

Page 24: STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM Managing Director ARM Tech, an Aon Company Presented by:

Example Success Story:A Work in Progress - Terrorism Pool

250 million xs 50-million250 million xs 50-million

40-million xs 10-million40-million xs 10-million

Companies set their own retentions and buy insurance

The first pool layer is “pre-funded”

The second pool layer is “post-funded”

Offshore Industry CaptiveOffshore Industry Captive

The premiums from the first layer are ceded by the pool to a captive owned by the members

Exhibit 22

Page 25: STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM Managing Director ARM Tech, an Aon Company Presented by:

A Word About Alternative Risk Vehicles

The Public Sector Bias• They are gimmicks to avoid taxes

– And not relevant to the public sector

• They create lots of “frictional cost”

• They require lots of new structure, which may not be politically palatable

The Truth• They are structured facilities that

can enhance long-term success of self-insurance or risk-retention programs

• The “value” of the added costs can be easily offset by:– Better terms/costs for

reinsurance– Allowing for participation by

multiple entities

• New tools (e.g., segregated cell captives) have greatly simplified formation and management

Exhibit 23

Page 26: STRIMA September 18, 2002 Branson, Missouri Alternative Risk Financing Steven P. Kahn, CPCU, ARM Managing Director ARM Tech, an Aon Company Presented by:

STRIMA

Alternative Risk Financing

Steven P. Kahn, CPCU, ARM

Managing Director

ARM Tech, an Aon Company

Jenny P. Emery

Senior Vice President

Towers Perrin Reinsurance


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