Organizations Can Benefit by Modernizing Risk Financing Strategies

Advancing technology and new analytics tools have put businesses in a position to better understand their risks and how they finance them, including the role of captive insurance.

As technology advances, the access to sophisticated analytical techniques is becoming widespread, said Paul Bailie, head of Offshore Americas Insurance Management at Willis Towers Watson. Those techniques allow companies to make better-informed decisions about risk financing, including both risk transfer and the cost of retaining risk, he said.

"Insurance buyers can now be better positioned on a more level informational playing field with insurance carriers, hopefully making the match there more equal as a result," Mr. Bailie said. He made his remarks earlier this year as part of a session examining "The Modernization of Insurance Risk and Financial Strategies" at the 2021 Virtual Bermuda Captive Conference.

Another speaker during the session, Sean Rider, executive vice president and head of client development, North America Risk and Analytics at Willis Towers Watson, discussed how risk financing strategies can be modernized and the role of captive insurance in that process.

Ultimately, the organization's risk financing strategy should determine the role for the captive, according to Mr. Rider.

"The captive shouldn't have a strategy," he said. "The captive strategy really should be derivative of the organization's risk financing strategy."

If an organization gets its risk financing strategy right around such issues as risk retention, risk transfer, and the amount of limits to purchase, "then the way in which the captive delivers value will fall from that," Mr. Rider said.

A captive insurance company, he noted, is "a brilliant execution tool for an organization's risk financing strategy."

Mr. Rider said that in today's business environment, underlying risks are shifting at the same time insurance buyers face a "crushing hard market.

"We're still in a hard market. We're seeing prices higher than they've ever been and capacity more constrained than it's been in modern memory at least," Mr. Rider said. Those market conditions are leading many organizations to rethink their approaches to risk financing.

At the same time, during the pandemic crisis many organizations' financial priorities have shifted, with an emphasis on hoarding cash.

"One of the questions I often ask is, 'Everyone's into this cash preservation mode. How has that changed your insurance buying decisions? How has that changed your approach to what risks you retain and what risks you transfer and why?,'" Mr. Rider said. "Has that allowed or created an environment in which we can reengage the question of your tolerance for risk and use that to parameterize organizational risk decision-making?"

The COVID-19 pandemic and its various impacts have led to operational disruptions at most organizations, Mr. Rider said. But more is likely ahead.

"Of course, operational disruption is something we've all been dealing with," he said. But, going forward, "When corporates hoard cash, eventually they want to spend it," Mr. Rider said. That's likely to lead to an intense 24-month period of mergers and acquisitions.

"There's going to be a very urgent need to rethink risk financing strategy in the context of upcoming mergers and acquisitions and integrating legacy risk management programs, integrating risks, and integrating those with an eye towards what it is we're trying to accomplish," Mr. Rider said.

At the same time, adapting to the current moment has allowed businesses to ask the question, "What are we trying to accomplish with insurance?," Mr. Rider said.

"Insurance is meant to be a financial tool. It's meant to be a mechanism through which we can suppress the financial consequence of risk in adverse cases. It's not really there for day-to-day stuff," he said. "The captive, as we all know, is an excellent mechanism for managing the ebb and flow of retained risks."

A captive insurance company provides a mechanism for gaining access to reinsurance markets, for building integrated risk transfer programs, and for structuring alternative risk transfer solutions to create options, Mr. Rider said.

"But fundamentally, we need to start with, what are we trying to accomplish? How much risk can we tolerate? At what point do our key financial indicators get out of whack and cause us problems? And what do problems look like?," Mr. Rider said. "So, what does it mean to protect ourselves, and shouldn't that parameterize our decision-making process about what limits we buy, what retentions we take, and how we use our captive?"

Answering those questions is essential to crafting an effective and appropriate risk financing strategy, according to Mr. Rider.

"If you don't know where you're going, any road will get you there," he said. "And if we're not thinking strategically, our tactics aren't going to make sense." Ultimately, the proper approach connects the risk financing strategy to the broader strategic priorities of the organization, Mr. Rider said.

A business can further modernize its risk financing strategy by taking a portfolio view of its risks, rather than viewing them independently, according to Mr. Rider.

If a business views all its risks as a portfolio of risk, it can unlock arbitrage opportunities in the insurance market, he said.

"Fundamental to that is understanding portfolio," Mr. Rider said. "Insurance companies look at risk as a portfolio all the time." Geography, line of business, severity, and frequency of the various risks in their portfolios all factor into deciding which risks they transfer through reinsurance and other mechanisms, as well as their investment decisions, he said. "There's no reason large corporates can't do the same thing.

"You can take advantage of the natural hedging that exists in that portfolio view, and you can orient your limits, and you can orient your retentions, and you can find structures and deploy them in such a way that allows you to de-risk to maximum effect for the lowest cost," Mr. Rider said.

Advanced technology makes it easier for organizations to take that portfolio view of their risks.

"Using analytics and technology and data visualization in support of that is the modernized approach to risk financing strategy," Mr. Rider said. "And the moment we're in today enables us to have it."

Such an approach allows an organization to connect its insurance buying to its broader financial priorities.

"This same approach to portfolio, of course, can be applied to the captive and its risk proposition," Mr. Rider said. Such an approach can allow the captive's parent to determine whether capital is under-deployed or over-deployed in the captive. Under-deployed capital can be returned to the parent, Mr. Rider said.