For corporations large and small the purchase of their traditional insurance protection typically includes a large deductible, which can be very expensive to reduce. Underlining an opportunity for the capital markets and parametric triggers to provide companies with a more efficient means of reducing risk.
The insurance-linked securities (ILS) market continues to expand its reach and deepen its relationship with the broader risk transfer landscape, a notion highlighted by the growing number of corporates utilising capital markets features to improve their risk transfer needs.
While the broad range of features, structures, and investors in the space are increasingly being used by corporations to protect against some of their catastrophe exposures, as seen with Amtrak’s PennUnion Re Ltd. (Series 2015-1) catastrophe bond, some feel the sector is poised for further expansion, outside of the nat cat space.
Beyond catastrophe exposures for corporates, and the potential for ILS to play a role in large-scale risks such as cyber and terror, James Crystal, Executive Vice President (EVP) of global insurance and risk management solutions firm Crystal & Co., feels ILS capital and features can be influential in helping organisations reduce their deductibles.
“In the traditional insurance models, companies buy their insurance in excess of a large deductible. A simple example would be a 5% deductible. If you’re a large organisation or even a smaller organisation, that 5% can add up to quite a lot of risk that they have to keep on their balance sheet,” explains Crystal, in a recent interview with A.M. Best TV.
Typically, for a corporation to purchase protection to cover or reduce the deductible is fairly expensive, so much so that it often stops organisations purchasing protection for this part of their insurance programme, essentially leaving them vulnerable to greater losses.
New Paradigm Group, a Florida domiciled parametric specialist programme manager that offers parametric re/insurance solutions, which, among other benefits are effective in reducing retentions for corporates, explained to Artemis why deductibles are expensive to cover traditionally.
“The insurance industry generally does a good job providing insureds a large limit of affordable indemnity protection for peak zone natural catastrophe perils (Wind and EQ). The industry is able to do this and still manage exposures to loss by attaching excess of a large “buffer” layer of the most likely losses through deductibles, exposures that are not traditionally insurable, policy language design including exclusions, and the claims process.
“This layer of “first dollar” risk is historically difficult to impossible to cover with traditional insurance as there is near absolute certainty it will produce large losses in any Windstorm or Earthquake event,” said Evan M. Glassman, President and Chief Executive Officer (CEO) of New Paradigm Underwriters, the insurance MGA subsidiary of New Paradigm Group.
However, with the use of capital markets capacity and a parametric trigger structure, corporations are able to achieve a much more efficient and adequate means of risk transfer, ultimately eliminating or reducing the deductible and therefore potential future losses.
Speaking to Artemis, Glassman explained what it is about parametrics that makes deductible protection more attractive to corporates.
“Parametric Insurance is a way to obtain a layer of “first dollar” protection for the losses that there is a near certainty will occur in any Windstorm or Earthquake event. It is balance sheet protection for exposures that are historically uninsurable.
“In a soft market, this gives many corporates an opportunity to invest a portion of their traditional insurance savings into lowering their Total Cost of Risk with a supplemental parametric insurance program to protect their balance sheets from economic losses beginning at dollar one from natural catastrophes,” said Glassman.
Furthermore, Crystal underlined that by utilising the capital markets in tandem with parametric triggers, risk managers of corporations, “are able to take that risk that historically they had to retain on their balance sheet, as uncomfortable as that might be, and they’re able to transfer that in a much more efficient way than they have in the past.”
The additional efficiency transferring this type of risk with capital markets backing was also highlighted by Glassman, who told Artemis that “in many cases, Capital Markets Capacity can be the most efficient for bearing pure peak zone risk as the capital markets investors are already viewing the exposure as non-correlated to much of what they are doing with the balance of their allocations.”
Crystal notes that currently, his firm is in discussions with a large real estate company in California, which buy a large volume of insurance protection against earthquakes, essentially waiting for the next “big one” to take place.
The larger the overall coverage this particular insurer acquires to cover earthquake losses, the higher the deductible will be, so the need to reduce and eliminate the deductible in the most efficient way becomes more apparent the greater the coverage.
A similar issue can occur for smaller companies, as a high deductible that’s expensive to reduce or eliminate via traditional insurance protection could leave them extremely vulnerable to future losses, which, can be extremely detrimental to the solvency of firms with a smaller balance sheet.
So the need to reduce the deductible for corporations of all sizes is important, and owing to corporations increasingly being comfortable with ILS features, as evidenced by their entry into the catastrophe bond marketplace, for example, there could be huge potential for ILS players to make inroads here.
Glassman told Artemis that at New Paradigm they are working to expand this type of protection into other risks/perils, and are currently “working on various opportunities including unique coverage for terrorism exposures where we are having strong success.”