Increased exposure to cat losses in Asia is encouraging firms to consider insurance to mitigate rising risk costs. Captives are set to form a key part of these efforts to contain risk exposures, writes Dwane Feehely.
Recent natural disasters, both globally and regionally, have been serious enough to place severe pressure on an insurance market that was already under stress and on the cusp of hardening. Munich Re, the world’s biggest reinsurer by premiums, recently warned that, in response, there would be broad price increases. There have been steep price increases for catastrophe reinsurance, and these are in turn driving insurance costs, particularly in those regions most exposed to natural perils.
Across the region we have seen events making the news almost daily with dramatic human, societal, financial and economic consequences for its citizens. They include:
• Thailand’s floods, estimated by Thailand’s insurance commissioner to amount to more than $30 billion of insured losses. This is in addition to losses from the 2004 tsunami and 2010’s civil disturbances;
• Floods in Australia in December 2010 which resulted in $5.1 billion of insured losses;
• Floods in China in May 2010 which resulted in $18 billion of economic losses;
• The earthquake in Christchurch, New Zealand in February 2011 which resulted in $9 to $12 billion in insured losses; and
• The earthquake and tsunami in Japan that killed an estimated 18,500 people and caused upwards of $30 billion in insured losses.
These disasters will inevitably lead the insurance industry to reassess weather and other natural disaster risks in Asia and the impact of increasingly urbanised populations, which often reside on floodprone reclaimed land. In addition, there are huge exposures and risks associated with rapidly expanding industrial zones—areas that are often situated on land which is vulnerable to earthquakes, storms and flooding.
Look at Thailand and we can see the results of these changing environments. The flooding in Thailand claimed some 562 lives and swamped around 960 factories in numerous industrial estates located north of Bangkok. This in turn disrupted the supply chains of international companies including Lenovo, Sony and Toyota. Globally it is estimated that personal computer shipments could be reduced by 20 percent during the first quarter of 2012 due to these events. This will compound the shortage of hard disk drives that was already evident prior to the floods, with Thailand accounting for around 45 percent of global hard disk production.
The climate is changing, and these developments will require us to think differently about how we manage risk. This will inevitably lead us to assess how we prepare for the changes in our business operations. These challenges will be particularly acute in Asia, as we increasingly urbanise areas of land by, or close to, the sea and low-lying areas.
These challenges will require us to rethink our approach to the management of risk and alternate risk-financing strategies which will include inevitably insurance. These rethought strategies will include the use of specialised vehicles to assist the provision of insurance and reinsurance solutions.
Following these disasters many companies and individuals found they were not insured for the risks they faced, or were underinsured, or were only partly covered for an array of contingent risks. They found themselves exposed to concerns such as business interruption, especially where the interruption was not caused by property damaged at the insured’s site. Typically this occurs following events that have an impact on access or suppliers.
It is important to judge scenarios when considering insurance in the face of natural disasters. The scenario approach must dive deep and look at multiple ‘what if’ situations.
With all of these challenges, what is a business to do to enable effective management and treatment of the risks the business faces? One vitalaspect is to develop processes to assess, quantify and determine the exposures and have a clear strategic approach to managing risk. One thing is for certain: a business with poor claims history pays more.
"For any business with a moderate asset base, premium volatility can be a challenging matter to deal with solutions are, however, available."
However it is not just the claims side that is causing consternation, it is how insurers perceive that you manage your risks and hazards. Insurers may pose many questions to you in an attempt to understand your risks. Typically those questions include topics such as building age, construction, protection features, location, your business and potential hazards. Critical to the assessment is to determine what steps the organisation needs to take to mitigate risk, such as the development of flood plans and levees, raising vulnerable plant above flood levels, additional bracing and fixing defences in wind-prone areas.
Given the significant increase in damage costs from natural disasters during the past 15 years, coupled with growing population numbers and assets being located in high-risk areas, we need to look at different approaches to risk transfer while businesses and property owners adopt more defensive strategies and mitigation measures. The ‘it cannot happen to me’ approach is clearly being challenged.
Inevitably, premiums reflect risk, which becomes a component to the cost of capital; this in turn is reflected in insurance premiums. Hardening markets tend to take an enhanced risk-based approach, while premiums in soft markets adopt a market share perspective. Nevertheless, premiums generally reflect the perception and assessment of risk. Businesses should thus be attentive to these signals as price consequences reflect an insurer’s view of risk profile. This requires a mitigation strategy that involves both the assessment of risk in terms of frequency and severity and an engagement in cost-effective mitigation measures to reduce vulnerability to catastrophes and mechanisms to manage working losses. This does not always happen and as a result pricing tends to fluctuate based on market sentiment.
For any business with a moderate asset base—which may include elements of property, equipment, stock, raw materials, finished products and business interruption exposures—premium volatility can be a challenging matter to deal with. Solutions are, however, available. One with proven long-term benefits is captive insurance. Such a vehicle is set up to provide insurance solely for the organisation concerned, which enables the company to retain risk at a level it is comfortable with,while at the same time having the financial capability to manage and smooth premium across the business.
The establishment of a captive requires a business first to consider what the risks are. There are various methods to develop risk tables, to determine what risks are tolerable, what risks are transferable, what risks need treatment and whether there may be some risks that should be terminated. Once this has been determined a captive can be structured and managed to deal with the risk-financing strategy that has been evaluated by the organisation to deliver the optimum outcome for them.
Setting up a captive is not a complex task, and Labuan International Business and Financial Centre (Labuan IBFC) prides itself on being a business-friendly environment for such structures. Labuan IBFC as a captive centre has been operating since 1996 and has developed a robust fiscal and regulatory environment. This, coupled with available expertise, competitive costing and sophisticated regulation, has attracted business, banks, insurers, reinsurers and captives to Labuan to establish their risk-financing entities.
New legislation introduced in 2010 has greatly streamlined the administrative procedures for captive insurers and introduced improved structures to enable the formation of captives via protected cell companies. In addition, Malaysia has long been regarded as the world leader in Islamic finance, and various structures are available to manage both conventional captives and Islamic or takaful captive vehicles.
Labuan IBFC offers local and global organisations the benefits of being in a leading international financial centre, captive insurance being one of the integrated financial services available from Labuan IBFC.
With increasingly challenging operating environments and reduced insurance capacity, coupled with a hardening market, now is the time to look at the strategic benefits associated with a captive insurance structure or any one of a range of financial services that Labuan IBFC has to offer.
Dwane Feehely is an insurance advisor at Labuan International Business and Financial Centre. He can be contacted at: firstname.lastname@example.org
EMEA, Labuan, property cat, captive, insurance