Digging In: Alternative Risk Transfer With Roberto Rivera

Intro (00:01):
You're listening to Digging In where we dig into the insurance topics, trends and news surrounding all things agribusiness. Here's your host, Bruce Droz.

Bruce Droz (00:17):
Hello everyone. This is Bruce Droz from Alliant agribusiness, coming to you today with another podcast, Digging In with Alliant. And today we have a special guest, Roberto Rivera, Vice President, and Account Executive of Alliant. And today we're going to be talking about alternative risk transfer, which is a term that I'm sure most of you have heard it. It's come to the forefront in this marketplace, the difficult insurance marketplace that a lot of folks have been dealing with here recently, but welcome Roberto.

Roberto Rivera (00:49):
Thanks Bruce, happy to be here.

Bruce Droz (00:50):
And we’re happy to have you as well. Let's start off. We kind of want to do, a who, what, where, when type of an approach to this alternative risk transfer subject, but why don't you tell us what is alternative risk transfer?

Roberto Rivera (01:05):
Alternative risk transfer is insurance speak for the conjunction between structured finance concepts. So, think investment banking and risk transfer. So, insurance, so it's a different way to fund for your future losses. It really came from the 1990s, after hurricane Andrew, people were looking how to better insure for future hurricane losses and CAT losses. So, the investment bankers got together with some insurance folks, and they came up with CAT bonds, just a different way to insure. So, that kind of took a life of its own into the structured finance world, basically looking for funding mechanisms to efficiently, try to pay for future losses. So, it took its own life, and it comes back up as the market hardens. So, thinking the early 2000s after the 2010, 2011 period, and now in the hard market. So, it's just a different industry terminology to define how to properly or more cost effectively ensure for future losses. Does that make sense?

Bruce Droz (02:17):
It does. And you and I have worked together on some of these types of programs, so got some insider of it. But for those listeners that still may be wondering who does this best serve, alternative risk transfer. What would be your thought on if you could describe a profile of a business that would find alternative risk transfer most appropriate and most useful, how would you paint that picture?

Roberto Rivera (02:43):
That's a great question. Right? How does it apply to just the everyday? And what we've learned is really there's three types of companies or folks that use these types of methods, large companies, right? So that's the easiest one. They have a lot of capital. They're looking to take some risk themselves because they think that there's a good return on their investments in the risk side. And they put together these types of structures to address that. That's an easy one. The more difficult ones, and kind of what we're seeing now, are those folks at who's premiums have substantially raised either as a function of their losses or in the alternative as the market has hardened, premiums have gone up substantially, and we're looking at multiples of the rate online. So, it's those companies that are buying, say a $10 million limit, and they're paying 10% of that limit in premium or 15%.

When it gets large enough for them to be able to fund for their losses and then pay the insurer, their premiums associated with putting the structures together with the idea they're going to save some money. And then further the last bucket of clients that look to use this are the ones that are looking to let's call them the first steps into funding for their own losses. So, basically looking for quasi captive structures, they might not be ready for a single parent captive or even a group captive, but they still want to be able to, to have some benefit from funding for their losses. So, those companies also look at alternatives transfers as all options.

Bruce Droz (04:20):
Roberto, I want to stick with this concept of who here for just another minute and appreciate your explanation there. But if we were to look in terms of the dollar size range, what these programs entail, not to pin you down to exacts, but just to paint a picture of the dollar sizes that we see involved.

Roberto Rivera (04:37):
Sure. Traditionally people start looking at alternative risk transfers when they started about that half million-dollar mark on a per year basis for any single insurance line. And those tend to be too small. So, it's really, when you start getting into the large six figures, small seven figure deals that this starts to really make sense. So, it tends to be larger purchases and it tends to be more complicated purchases or when a client has no alternative. Honestly, and we had a client recently who had suffered a string of losses and he had very limited options in a specific area of insurance. So, they had to use alternatives transfer to help them out during that renewal cycle. That's really the sweet spot, large six figures, small seven figures.

Bruce Droz (05:27):
In the example, you just gave us, is a good segue into the next piece of this is like, okay, we talked about who, but when is it appropriate? You mentioned a situation where there was a string of losses and the marketplace was probably driving, that thought process. But any other examples of when the alternative risk of transfer approach can be very useful and appropriate,

Roberto Rivera (05:48):
Certainly, alternatives transfer primarily is a way to create leverage over the marketplace. It’s an alternative for a client. So, you can certainly look to alternative transfer methods to help you compare rates to the current market. So, an easy example would be the auto liability market in the last five years has hardened substantially and buffer layers have become common in many programs. So, looking at those buffer layers, which fit this idea of rate online, 10 to 15% of the limit, as well as total premium, half a million, $700,000. So, you start looking at alternatives transfer placements to compare what the benefits would be of funding for your own laws. And the idea is that, especially in auto liability where the claims tail is relatively short, you're able to quickly know if your structure became a better prospect than buying traditional insurance. So, you kind of create your own funding and alternative to the traditional marketplace and you start making that comparison.

So, that's probably the primary driver of when to use this. The second opportunity that we look for alternative transfer is when we are trying to hedge against future inflation. So, we expect a hard market. We expect it to happen this year, next year, and the year following that. So, transfer lends itself for multi-year placements. And the idea is to hedge against future inflation, you would pre-negotiate your rate for the next three years, basically understand what that rate growth will be, and you're trying to hedge against those subsequent years. So, that starts to create some leverage in the client's favor. And then finally, it's taking a longer view of capital needs as you start funding for your own losses and you're recognizing your loss base. And you're recognizing that you have a little more capacity to, to affect your future. You start taking a longer view of your capital needs and alternative transfers, particularly good for that.

So, let's say you're trying to figure out how to properly structure your business for the next five years. Definitely alternative transfer methods play into that multiyear multiline placements, multiyear placements by themselves, or combination of the two. You also look at alternatives of how to properly ensure for CAT risks. And we mentioned earlier CAT bonds as an alternative, you can try to place them. They even come down pretty low in marketplace, but the idea is that you're no longer in a 12-month cycle. You're starting to look at the placement over a 36 or longer period of time. And one of the common sayings from in this word is you don’t have all your debt maturing in one year. So, why would you have all your insurance maturing in one year? That’s kind of the idea, you're hedging against future inflation with multi-year lines, as well as looking to fund for those losses. That's really the three areas that when we look at this.

Bruce Droz (08:59):
That was well said, Roberto. And it really points out that this involves a blending of that financial lens and the insurance risk management lens. It brings the two worlds together in an approach to managing and financing risk. We mentioned a couple of areas where this comes into play, but let's dig a little deeper into the where again, and you mentioned some, but maybe some other examples to drill down, on where we've seen this really help.

Roberto Rivera (09:31):
Yeah, definitely. I would say in the products liability side and products recall side, it's very common. Those are losses at large clients or medium size clients tend to expect and know their products. So, alternatives transfer particularly lands itself well for that. So, you have a history of losses, you understand it, and you can fund for that to a level that you're comfortable with. And you use alternatives transfer to basically seed off the risk that you don't want, or the unexpected loss, if you will. Captive like reinsurance products, that's the first step towards a captive. A captive is just a tool to address your risk in a different way. Structured program has many of the benefits of the captive while still allowing you a relatively easy offramp. Once you go into a captive, it's definitely a longer cycle to get out of it, if the company wants to.

And then finally on larger risks, right? Risks that have either large loss histories for whatever reason, or just risks that are growing alternative risks transfer definitely lends itself for it. And I'll give you kind of a couple of examples of how these things tend to work. You mentioned earlier the auto buffer layers as something you can use. And the idea is that you certainly have a loss history that the market recognizes, and marketplace and insurers price out the risk before them with appropriate premiums. So, when those premiums get pretty high, you have an opportunity to fund for those losses. So, as risk grows and it's larger in scope and scale, being able to fund for those mechanisms outside of a captive or outside of a group captive is definitely lends to itself to these steps of placements.

Bruce Droz (11:15):
Thank you, Roberto. How about some other examples of where we've seen this come to play?

Roberto Rivera (11:19):
So, we spoke earlier about rate online and the concept is, what is the return on any single capacity that's being provided by an insurer? So, you asked an insurer to provide a 10 million line of insurance, call it an umbrella or an excess placement. So, from an insurance perspective, part of the financial mechanics behind it, is how much they're getting back in terms of rate. So, rate online is just the industry term for the percentage of the limit that is being charged as in premium. If you have a $10 million line where the insurer is charging a million dollars in premium, it's a 10% rate online. So, the idea is that as that number grows, the alternatives for financing that risk are larger. And then that kind of lends us to step two. It's like, okay. So, we've identified that the rate online is 10% and there's an opportunity to fund for your own losses.

So, what are the structures that we can use to do that? And some of those are starting to look at the insurance in a different way. Normally we just buy a single line of coverage that provides X amount of limits, and you expect it to cover you both in the aggregate losses, so many losses or in a single large loss. So, when we unbundle that we start looking at, there's actually two insurance products there. There are the aggregate losses, which is many smaller losses. And then there's the catastrophic losses, which is single large loss. So, when you use our alternative risk transfer methods, you can fine tune those two purchases. And you might determine that for the case of auto, you're really not worried about maybe the aggregate losses. You have a good driving record, and you're really just worried about a nuclear verdict. So, you can fine tune their purchase to eliminate part of that aggregate coverage and just concentrate on the vertical loss, the catastrophic loss, and that tends to lead to some premium savings as well some financial benefits to the client.

A very common alternative risk transfer method, especially on legacy companies is loss portfolio transfers. You see them on the workers' comp more often, and that's when a company wants to get rid of or seed legacy risks. They want to get them off their balance sheets. And there are insurers that will help you do that. Think about an old legacy company that has workers' compensation with a very long tail. You don't want to be involved in that management, you package it up and you sell it to an insurer that does that. Limit sharing, it's lesser used right now for whatever reason, but you can certainly share limits amongst lines that have less frequency. So, in the construction space, it's very common for example, to have a contractor's professional and pollution policy, a CPPI or a CPP policy.

And that is an example of alternatives transfer, where you're sharing a limit. And that's very common in the construction industry and it's been packaged and sold widely in all our clients. And finally, I would say the last one that's most common it's structured risks and structured risks are basically the methods used to fund for your losses, your expected losses, and offset the unexpected losses with insurance. So, you expect say a hundred thousand dollars in losses, you fund for that through a structured program. And then you offset the rest of the risk, the north of a hundred thousand dollars in losses with insurance. And that is the concept, right? It's basically looking at insurance from a financial perspective and seeing where are there opportunities where you can capitalize on your capacity, on your available capital on your funds and try to offset some of that cost of risk that might be very high, or you might not have alternatives. And that's really what this is about.

Bruce Droz (15:23):
Yeah, I do look at this as a way to find creative solutions to clients solve their problems. I've certainly enjoyed Roberto working with you on several of these types of alternative risk transfer programs. You are a wonderful resource in that area and very knowledgeable. So, with that, we should probably wrap it up. And I want to thank you, Roberto, for joining us today on our podcast for Alliant agribusiness. For listeners out there, thank you for listening. And for more information, please go to www.alliant.com.