A broad and simple definition of Alternative Risk Transfer is when a commercial insurance consumer assumes a portion of its own risk in exchange for lower premiums or a reduction in their net cost of insurance.
Alternative risk transfer is growing because high performing companies:
- don't want to pay high premiums to subsidize low-performing members whose premiums are inadequate to pay their claims
- gain access to profits (underwriting profit and investment income) generated from current insurance premium
- get more control of claim management, risk management, and with whom they share their risk
- gain stability and predictability in their premiums rather than the typical market swings of the insurance industry
What are some of the options available within the alternative risk transfer market?
High Deductible Plans
Here the insured is retaining the difference between gross loss and the deductible amount. The size of the deductible, the number of claims, the nature and severity of loss and claims handling costs, and the financial stability of the insured will determine whether the insurer will require collateral to be posted, guaranteeing the loss within the deductible. On the assumption that the insured's deductible contains "expected" losses, the reduction in overall premium will be significant.
Self-Insured Retention (SIR) Plans
The use of self-insured retentions is different. Here, the insured not only assumes the difference between what will be defined as gross loss and the retention, but in the majority of instances, will also be responsible for the defense of claims and their attendant costs. They will purchase insurance to cover the amount of loss in excess of the Self-insured Retention. For the Self-Insured retention, the insured can purchase claims service legal support from the insurance company providing the excess of loss insurance policy.
As in the case of deductibles, the insurer may require the posting of collateral to protect defined losses within the program. Just as with the deductible approach, the overall pricing for an SIR approach will dramatically reduce costs by virtue of risk transfer.
Collateral
Posting collateral has a two-fold purpose. It creates a funding mechanism for the presumed loss in the case of either deductibles or self-insured retentions, or it protects the insurer's balance sheet integrity, for statutory filings.
Retrospectively Rated Plans
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Risk Retention Groups
Risk Retention Groups are owner controlled insurance companies authorized by the Federal Liability Risk Retention Act of 1986. A RRG will allow members who engage in similar or related businesses or activities to write liability insurance for all or any portion of the exposures of group members, excluding first party coverages, such as property, workers compensation and personal lines. Authorization under the federal statute allows a group to be chartered in one state, but are able to engage in the business of insurance in all states, subject to certain specific and limited restrictions. The Federal Act preempts state law in many significant ways.
Advantages:
- Avoidance of multiple state filing and licensing requirements.
- Member control over risk and litigation management issues.
- Establishment of stable market for coverage and rates.
- Elimination of market residuals.
- Exemption from countersignature laws for agents and brokers.
- No expense for fronting fees.
- Unbundling of services.
Disadvantages:
- Risks are limited to liability insurance.
- Not permitted to write outside business.
- No guaranty fund availability for members.
- May not be able to comply with proof of financial responsibility laws.
Captive Insurance Company Formations
Single Parent Captive - A closely held insurance company whose insurance business is primarily supplied by and controlled by its owners, and in which the original insureds are the principal beneficiaries. A captive insurance company's insureds have direct involvement and influence over the company's major operations, including underwriting, claims management, policy and investment.
Rent-A-Captives - An insurer or reinsurer that rents its capital, surplus and legal capacity to client users. The sponsor, not the policyholder, controls the rent-a-captive and usually provides administrative services, reinsurance, and/or an admitted fronting insurer. The insured's underwriting account is typically segregated from the other insureds of this entity. This segregation can be achieved by words, through accounting procedures or statutorily. It can also be called a Protected Cell.
A PCC is a single legal entity that operates segregated accounts, or cells, each of which is legally protected from the liabilities of the company's other accounts. An individual client's account is insulated from the gains and losses of other accounts, such that the PCC sponsor and each client are protected against liquidation activities by creditors in the event of insolvency of another client. Many domiciles have enacted legislation enabling the formation of PCCs (e.g., Guernsey) or other similar structures (e.g., segregated account companies in Bermuda and segregated portfolio companies in the Cayman Islands). Group Captives - A captive insurance company with more than one owner, typically members of an industry trade association. Sometimes the association itself is the owner of the captive. This is a generic term for all types of group-owned captives.