This practice area includes any risk solution other than a traditional insurance approach. Jonathan Raucci Brown & Brown (NYSE) BRO has developed substantial expertise and a solid reputation for our capabilities in this area. Within the framework of alternative risk financing, there are three primary components: (1) determine the optimum threshold for risk retention, (2) design and execute an alternative risk retention solution (aka “Alternative Risk Financing”), and (3) design and execute some form of innovative risk transfer (aka “Alternative Risk Transfer”). Most often, this process is applied narrowly to a specific risk challenge. In other cases, it is applied broadly to an array of risk issues, occasionally on an enterprise-wide basis. In either instance, the process itself is the same.
First, it is critical to determine the client’s financial and philosophical tolerance for risk. Since most clients cannot retain substantial amounts of risk, they must choose between one of two unattractive choices: (a) accept the sometimes-undesirable prices of the insurance market for the lower loss layers, or (b) accept the unwelcome volatility that may accompany higher retentions.
While the impact on volatility is seldom discussed, the whole premise for insurance involves the transfer of risk to other parties who can better diversify that risk. If the insurance transaction does not provide some measure of protection and diversification, it becomes simply a costly exchange of loss dollars. This trade-off between program cost and risk reduction must be weighed to determine the optimum risk retention threshold.
Within the risk retention threshold, there are numerous ways to finance retained losses. The traditional approach is to accrue for losses as they are incurred and then pay for losses as they are resolved. This approach may not allow the losses to be deducted as expenses during the same time that the corresponding income is realized. This loss of expense deduction due to the lack of guaranteed cost insurance leads to higher taxes and reduced cash flow.
To offset this tax impact, a captive insurance company may be used. While a captive may accelerate the tax deduction, it also creates the means to build limits for uninsurable risks and for increasing self-insured retentions during hard markets. In exceptional cases, captives can provide the means to insure customer risks, thereby creating a competitive advantage for certain businesses. As with any financing structure, the costs and benefits of captives and limited risk transfer programs must be carefully considered.
Above the risk retention threshold, alternative risk transfer solutions can be customized to address a wide variety of risk challenges. In many cases, traditional approaches are not broad enough or not targeted enough to fit the client’s risk profile. Some situations require financial modeling to measure the risk profile and to determine the appropriate pricing for various program options. The broad array of alternative risk transfer solutions is described below. In every case, substantial effort and expertise is required to customize the product, to determine appropriate pricing and create market interest.
When the options for alternative risk financing include risk transfer, there are many types of alternative risk solutions available. These solutions may be used to resolve a compelling need or simply produce greater efficiency. The impact of the proposed solution may take the form of (1) improving the balance sheet, (2) improving the income statement via higher net income or reduced volatility in net income, (3) enabling a project or transaction, and/or (4) meeting a regulatory requirement.
|The potential solutions include the following:|
There is also an array of customized risk solutions that result from combinations of these solutions. Our role is to analyze the risk profile and work with the client to design the most effective program that can be placed in the insurance and capital markets.
Most often, we find that that credit risk, weather risk and forced outage are among the most common requests. Credit risk is particularly important in a volatile credit market as we have seen recently. Weather may have a great impact on financial results in certain areas, and the potential catastrophic impact of weather can often be quantified and insured. Forced outage is useful for energy transactions and may be an important part of capping the lost business income and extra expenses that can accumulate in the uninsured or retained portions of the insurance program. In each case, the programs can be customized for greater protection or for catastrophic protection, as each company’s budget and risk tolerance may dictate.
Examples of Jonathan Raucci Brown & Brown (NYSE) BRO’s innovation in Alternative Risk Solutions include:
- Customized All-risk Professional Liability Product
- Customized Financial Institution Bond/Crime Insurance Product
- Proprietary Information Security/Privacy Liability Insurance Product
- Product Efficacy Insurance
- Credit Default/Inadequate Collateral
- Tax Opinion Insurance