Emerging risks: embracing innovation

The past five years has seen some significant changes to the ways in which insurance and reinsurance is transacted.

The proliferation of new insurance-linked securities (ILS) investment vehicles and a wave of new hedge fund-backed reinsurance capacity continues to distort market conditions, forcing rates to remain at seemingly unsustainable levels.

One of the resultant consequences is the growing trend of mergers and acquisitions (M&A), which arguably came firmly onto the insurance industry’s radar upon the announcement of the $4.28 billion XL Catlin merger.

The activity in this regard is acutely necessary and may become endemic. It is not limited geographically, nor are insurers and reinsurers the only ones affected. Brokers have been rapidly following the same M&A path—with another rumoured big name merger likely to become a reality before the year is out.

With the aforementioned situation in mind, the question facing many of us is: how will this affect the captive industry?

Given that Hyperion’s structure includes both an independent insurance management practice and a specialty risk intermediary, we often feel that we are in a somewhat privileged position. In uncertain times, we are fortunate enough to have two very different and equally important industry perspectives.

While many captive industry commentators tend to focus on the link between hard and soft commercial market cycles as being the key driver for captive formation activity, we have a somewhat different perspective.

Although it is clear that the captive industry and the commercial insurance markets are inextricably linked, the continued success of the modern day captive industry, just like that of its commercial insurance counterparts, will be driven by innovation—not by premium rates and cycles.

To further explain this theory, it is important that we first consider the two focal points of most industries seeking to secure new sources of revenue: product and distribution.

From a commercial insurance distribution standpoint, there are some very obvious indicators of where insurers and brokers are focusing their efforts. Read any daily industry news publication, email update or tweet and you will undoubtedly be advised of an intended expansion into a perceived ‘emerging market’. These could be along the lines of ‘new Lloyd’s office opens in Colombia’, or ‘Hong Kong-based reinsurer acquires a stake in MENA regional insurer’. Regardless, the trend is abundantly clear.

So does this mean that insurers simply concentrate their efforts on ‘emerging market’ distribution and forget about expanding revenues in their core (but often saturated) developed markets, such as Europe and North America? The answer is ‘No’. They task themselves with continued growth through the other apparent source of new revenue: product.

Ways to survive

Product innovation is now an integral part of survival in some quarters, so insurers, reinsurers and intermediaries alike, all need to embrace the likes of transactional liability, cyber liability, trade credit/trade finance, political risk, political violence and other coverages. However, as with all insurance product lines, it is important to remember that there will always be coverage gaps, disputes over trigger points and other unknown quantities that can leave the buyer with significant uninsured exposures.

The cyber liability market is a case in point. Despite the class being at the forefront of the industry press and conference circuit for a number of years now, there are still many unresolved issues from a coverage perspective. For example, how does a policy react in the event of a data breach that follows a power outage that increased vulnerability? Moreover, in an ever-evolving technological world—where the hackers are far more advanced than the world’s largest governments (by their own admission)—finding a balance between what can and cannot be covered is, in itself, a monumental challenge.

This leads us nicely in to the correlation of the commercial insurance and captive industries and how they continue to co-exist harmoniously—at least for now.

Captives, by their very nature, are risk financing tools that bridge those gaps. They are risk aggregation vehicles that can help a business successfully, or at least pensively and strategically, plan for the future—even when the future is uncertain.

Unfortunately, the current reality is that much focus and perception is placed on captives being a mechanism to participate in commercially insured risks. While this will always be one function of captive use, many of us believe in the notion that captives can actually provide a far more sophisticated risk management and business enhancement tool.

A good example of this relates to a project that we have been discussing with an extremely innovative industry colleague. It involves utilising captives as a means of offsetting future carbon emissions and managing them successfully over time. This is linked to similar concept surrounding climate change and, again, involves ground-breaking new ways in to address a major corporate risk issue that is largely incomprehensible to the traditional markets. These concepts and ideas are what we mean by ‘product’ in the captive sense.

Access to market share

Reverting to the ‘distribution’ angle, like our commercial insurance partners, we in the captive world are also pursuing emerging markets, with the majority of more recent opportunities arising from Latin America, MENA and South East Asia.

Our captive approach in these markets is vastly different to that of commercial insurers. In general terms, many commercial insurers’ and reinsurers’ strategy is to access market share and, perhaps, over time, introduce new products as demand and insurance penetration dictates. In contrast, captive practitioners are already assisting our clients by introducing them to risk financing solutions that the local insurance market does not actually provide for.

In South East Asia, we are helping clients to adequately finance uninsurable natural catastrophe exposures. In Europe, we are structuring fronted reinsurance programmes to incubate bold new risk takers that are seeking to change the way consumers buy insurance. In Latin America, we are providing banks with access to purposely formed, A-rated, risk participation vehicles to expand and diversify their revenue streams. In North America, we are assisting various businesses with desired expansion by showing them how to use trade credit solutions as a means of cash-flow creation and business enhancement. This is how we must now approach ‘distribution’ in the captive world.

Essentially, access to new and innovative solutions for pioneering captive owners is largely dependent on two key decisions, both of which are at the initial stages of the process: choice of service providers and choice of jurisdiction. Collectively and separately, these are integral to long-term success.

In summary, the term ‘emerging risks’ may spark thoughts of new and developing business lines to some. To others, it may simply be more akin with geography. Either way, both are equally important to the future success of the commercial and captive insurance. The embracing of innovation was at the forefront of the industry—and remains so to this day.

About the Author:

Simon Owen is the principal/CEO of Hyperion Risk Solutions and Hyperion Insurance Management group of companies, and a shareholder/director of Ensurion W.L.L., a long-established insurance management practice based in the Middle East. He is also a founding partner of an international trade credit and political risk insurance intermediary, based in Ontario, Canada.

He currently serves as a board member of the British Chamber of Commerce in Panama and of GBN Worldwide, an international business network. He is a past chairman of the BVI Association of Insurance Managers, and has served as a member of various other financial services committees. He is an accredited member of the Society of Trust and Estate Practitioners and is a regular speaker at international finance and insurance events.