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BT EXCLUSIVE

Alternative risk transfer taking insurance industry by storm

Over past decade, it has soared 410%, in contrast to traditional capital's growth of about 50%

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The Monetary Authority of Singapore (MAS) is keen to tap into this growth opportunity and has set up an ART workgroup to advise it on initiatives to support the development of Singapore as an insurance-linked securities (ILS) hub.

Singapore

IMAGINE you are the owner of a nature resort and a major wildfire sweeps in, leaving a trail of devastation over a vast swathe of forest but which miraculously spares your property. Or suppose you have a small factory dealing in auto parts in an industrial park when once-in-50-years torrential rains bring widespread flooding that inundates the park - but not your premise as it is on high ground - and blocks road access for months.

Now if you have bought traditional commercial property insurance that covers the usual risks of flood and fire damage, you may wish you were not so lucky and that your property had perished with the rest (but not lives, of course). Since there is no actual damage to your property you get zero payout, never mind that you are out of pocket from the loss of revenue and supply chain bottlenecks as guests and customers desert you and suppliers are cut off.

In other words, the losses do not stem from physical damages but business interruption.

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This is where alternative risk transfer (ART) solutions can save the day.

ART is a fast growing area in the commercial insurance market. According to industry sources, the amount of available alternative capital has grown by about 410 per cent from US$19 billion in 2008 to US$97 billion in 2018. In contrast, the amount of available traditional capital increased by just over 50 per cent in the same period.

Alternative capital now also accounts for a greater proportion of available global reinsurance capital: 16 per cent in 2018 compared to just 6 per cent in 2008.

The Monetary Authority of Singapore (MAS) is keen to tap into this growth opportunity and has set up an ART workgroup to advise it on initiatives to support the development of Singapore as an insurance-linked securities (ILS) hub.

In February, MAS launched the ILS grant scheme, which will fund up to 100 per cent of upfront issuance costs of a ILS bond in Singapore, to catalyse the ILS market here.

"One of the key advantages of ART is that it protects revenue. Traditional insurance is very focused on physical damage, whereas from an ART perspective we are much more focused on protecting a company's revenue streams rather than its physical assets," Chris Fischer Hirs, chief executive of Allianz Global Corporate & Specialty (AGCS), told The Business Times in a recent interview.

AGCS, a property-casualty insurer, is part of Germany-headquartered financial services giant Allianz Group.

"Think about a hotel in Macau, as an example, after a typhoon. It's not the physical damage to buildings, that's covered by traditional insurance. Because there is no access to the hotel there is a loss in revenue, less nights spend. If the hotel is running a casino, there is less revenue from the casino, gift shop and other facilities. So we look at the weather as the trigger (for insurance payouts)," he said.

Parametrics - one of the solutions under ART - can help to bridge the gap in traditional insurance. Also known as an index cover, parametrics are a form of insurance that pays out based on predetermined triggers without requiring to show physical losses on the part of the insured.

The trigger typically consists of quantifiable, physical characteristics of an event, such as wind speed rising above a certain level or an earthquake registering a predefined magnitude at a certain depth.

Once those parameters are triggered, the ART coverage pays out. This means risk managers can effectively plan for and cover losses of revenue that are not related to physical damage. ART solutions are also helping to open avenues for insurance to clients that may otherwise be shut because their insurer is not able to take more risks onto its books.

Mr Fischer explained: "Take earthquake risk in Japan, for example. We may have filled our risk appetite for Japanese earthquake but we are still interested in the client relationship so we take the traditional fire and explosion risks onto our books, but the earthquake risk we will then reinsure to third-party capital so someone else is carrying the risk of an earthquake."

With climate change a buzzword these days, businesses are also increasingly vulnerable to adverse effects from natural catastrophe and weather-related events. The risks associated with these events lend themselves well to parametrics.

For example, in a renewable energy plant where costs are often benchmarked against those that run on fossil fuel, the cost of financing and its projected revenue are key considerations to getting the project off the ground. Parametrics can make a seemingly unviable project viable.

AGCS recently picked up the Insurance Innovation of the Year award for Asia Pacific organised by StrategicRisk, an industry magazine that reports on corporate risk management and insurance, for putting together a parametric solution for a solar farm in Australia.

"Think about a solar farm. If there is not enough sun, there may be a drop in revenue. But because we guarantee the revenue, the financing for that solar park gets better financing conditions, it gets our double A rating (AGCS is rated AA by S&P). The revenue protection allows the solar park to stay in the business and get cheaper financing," said Mr Fischer.

A solar farm insured under parametrics can receive a payout if the number of sunny days in a year does not hit a predefined minimum.

Because the underlying matrix is transparent, parametrics are gaining popularity in capital markets, with established insurers like AGCS increasingly structuring and selling such solutions to investors for a fee.

ART accounted for 20 per cent of AGCS gross written premium of 8.2 billion euros in 2018.

Apart from possibly getting higher returns than bonds or even equities, investors of parametric products also benefit from risk diversification in their portfolio as property-casualty insurance has low to zero correlations to other asset classes.

"ART allows investors to participate in a risk class that they otherwise would not have access to," said Mr Fischer.

One such deal involved helping the World Bank to provide disaster relief for the Philippines in the form of a natural catastrophe parametric cover.

To help the Philippines obtain coverage, the World Bank acted as an intermediary to transfer the risk of natural catastrophe losses outside of the country by executing a catastrophe swap transaction with insurers, including AGCS, Munich Re and Swiss Re as well as investors ILS investment fund manager Nephila Capital and Swedish state sector pension fund AP3. The US$390 million policies cover 25 provinces on the Philippine eastern seaboard, focusing on protecting national and local government assets against natural catastrophe incidents, specifically typhoons and earthquakes.

READ MORE: Insurer AGCS 'seeing a much stronger increase in premiums' for 2019