Every soft insurance market raises the inevitable question for risk managers: Why do I need an alternative risk-transfer vehicle when I can easily get coverage in the standard market? But to even ask the question is to miss the point of ART.
In theory, the goals for using an alternative risk-transfer structure do not differ significantly between market cycles. Any qualified insured considering long-term benefits of ART will generally find that establishing such a structure in the soft market–which at first may seem counterintuitive–will pay dividends when the market turns.
Prospective ART buyers should not ignore the potential to control their own destiny in a soft market just because more insurance options are available and overall prices are cheaper. Those buyers who consistently achieve good loss results, actively promote risk management techniques, and would like to decrease the effect that insurance market cyclicality has on their business, should have finding an ART solution at the top of their list.
When contemplating whether to set up or stay in an ART solution, it is important to consider the tangible as well as the intangible benefits. While the cost to establish an ART structure will be inherently less expensive in a soft market, you should view your entire analysis over a three- to five-year time span, since an ART structure or product is a long-term investment, not just a short-term cost.
Insurance buyers with riskier exposures cannot ignore the fact that traditional insurance alternatives may not even exist when the market turns hard again. Time and time again, certain coverage–such as product liability for medical device manufacturers or professional liability for nursing homes–becomes unavailable, or at least unavailable at a reasonable cost when the market turns. Needless to say, a lack of insurance coverage can jeopardize a company's very existence.
If you wait until a time when your only insurance option is an alternative risk-transfer structure, you usually will have very few vehicles from which to choose. Not only will the available structures or products be limited, but they also will be more expensive to create. You may find yourself trying to set up your ART structure while already dealing with other financial impacts on your business.
Creating an alternative risk structure during the soft market will give you the time needed to adjust to the new structure and your team will be much more likely to retain focus on managing claims costs. These structures can take several weeks to several months to implement, and setting up in this market gives adequate time to fully execute the implementation.
Some structures can be quite complex, and managing a new insurance structure during a hard market–when just managing your business may inherently be more difficult–can create unnecessary stresses on the management team.
Furthermore, the ability to build surplus capital while fixed expenses and claims costs are less expensive can be significant, since it is this surplus that can become extremely beneficial when dealing with the impact of a market change.
In this current soft market, there are various creative ART structures to consider.
The first structure that you will almost only see in this market is a quota-share reinsurance arrangement that, with a captive, is a viable mechanism to reduce the amount of collateral needed for a fronted captive structure.
A quota-share arrangement is when the captive reinsurer shares a specific loss retention layer with another reinsurance company or their fronting carrier instead of retaining that layer 100 percent themselves.
Quota-share arrangements usually disappear once the hard market returns, because the underwriting requirements of insurance and reinsurance companies make this option less attractive.
Joining a group captive or group program is another creative soft market strategy, since many insurers will focus on organic growth by adding to their existing group captives or programs. This organic growth also occurs when one insured acquires another.
Group captives are a good alternative for small- and middle-market companies and give them the same benefits usually reserved for larger insureds establishing their own ART structures.
Even though traditional program business does not use a reinsurance or captive structure, it should still be considered as an alternative to a stand-alone guaranteed-cost option, especially for any company with "hard to place" risk, or that has had difficulty finding coverage in the past.
A third soft market option is for an insurance carrier to "warehouse" an insured for the first year. Warehousing allows a business that is not quite ready to set up a captive to build a relationship with a carrier that involves retaining some risk.
The insurer can warehouse the client's business by writing a large deductible or guaranteed-cost policy for one year, until the buyer is ready for its own ART structure. During this first year, possibly while waiting for the acquisition to come through, the carrier-insured relationship can be established.
Together, they can work toward creating an ART structure that fits that client's situation. The client's relationship with the insurer will be well established when the client is ready to implement the captive program. This warehousing option is unlikely to even exist during a hard market.
For all of these structures, the key intangible benefit to consider is the importance of establishing a positive relationship with a fronting carrier and reinsurer as your alternative risk partners.
Building these relationships during a soft market works in your favor because insurance companies and reinsurers face increasing competition and, therefore, are often more willing to be creative. It is at this time that the emergence of "soft market structures" can be found.
It is to everyone's benefit–insured, insurance company and broker–to take advantage of these opportunities. Building this relationship by managing claims costs and fulfilling obligations in the partnership will over time lead to decreased expenses and collateral concessions regardless of market conditions.
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