The FINANCIAL -- The latest sigma study "Commercial insurance: innovation to expand the scope of insurability" is about the innovative risk transfer solutions available to cover the ever-evolving range of exposures that companies face.
Product development and innovation around data and data analytics have expanded the scope of insurance solutions to a wider range of threats and perils, and made risk transfer more efficient. In addition, companies are using novel insurance solutions to protect earnings, reduce cash flow volatility and support business strategy and growth.
Technological, economic, demographic, societal and geopolitical macro trends are driving deep changes in the business environment. These structural changes create new opportunities, but also new risks. At the same time, the corporate sector has changed from being dominated by physical assets to deriving more value from intangible assets, such as intellectual property, networks, platforms, data and customer relationships. These transformations and the associated exposures they create are mirrored by surveys of risk perception by companies. For example, today business interruption, due to cyber and supply-chain risks, is the key corporate risk concern, according to surveys of risk experts across the globe, according to Swiss Re.
New solutions make risk transfer more efficient
"New types of solutions are providing protection against a wider range of perils, and extending insurance cover from tangible to intangible assets," says Kurt Karl, Swiss Re's Chief Economist. For example, holistic covers combine multiple risks and/or interdependent triggers, and allow better alignment to the specific risk transfer needs of an insurance buyer. "In addition to offering coverage for multiple risks, holistic solutions offer efficient risk transfer given their focus on the joint distribution of all risks."
Parametric solutions based on indices rather than actual losses also offer efficiency benefits. The biggest advantage of parametric triggers are their clarity and neutrality: an insurance pay-out is triggered if pre-set conditions are met, providing a quick, pre-agreed pay-out without a lengthy claim investigation. For this reason, parametric solutions are particularly useful in managing earnings volatility or for business interruption type coverage, with or without physical damage to property. The utility of such solutions is demonstrated by a recently developed multi-year parametric cover for earthquake events of minimum magnitude bought by a US state government entity with property assets spanning a wide area. The main objective of the buyer was to secure sufficient post-event liquidity to manage the initial cash flow needs after an earthquake event, such as for emergency evacuations and to facilitate access for repair work.
Reducing earnings and cash flow volatility
Insurance solutions are also increasingly being used to protect earnings and cash flow risks. Some previously uninsurable non-core business risks can now be insured to some degree, due to the evolution of triggers, indemnity structures, and data and modelling advances. Examples of perils that can be covered in more innovative ways include non-physical damage business interruption, cyber, product recall, as well as weather and energy price risks.
For example, in Brazil, which is the world's third largest producer of hydropower and which is also recovering from its worst drought in 40 years, an energy trading company wanted to hedge its exposure against future drought risk. A customized derivative solution based on an index that measures a river’s natural flow has been developed. The index is calculated daily by an independent body responsible for coordinating and controlling electricity generation and transmission facilities in Brazil. If the index falls below a defined threshold, the derivative pays financial compensation. The index-based deal hedges the trading company's position against drought risk – its most important weather-related risk – and will help stabilise its expected earnings in the future.
Supporting business strategy and growth
There have been cases where novel solutions have enabled the operation of new types of business models such as sharing economy start-ups, and even allowed companies to utilize risk transfer for marketing support and product differentiation. For instance, in China a company wanted to promote a client loyalty programme that would allow local farmers to benefit from free-of-charge replacement for already purchased pesticides if their crops were damaged by a severe storm. The manufacturer's objective was to transfer this risk exposure to the insurance market. In addition to boosting sales, the pesticide manufacturer can increase client loyalty by offering an insurance add-on to its product, and also justify a small price increase for the product. The benefit to farmers is that the free-of-charge replacement feature provides financial relief when they need it most.
Expanding role of corporate risk management
Corporate risk management is becoming more sophisticated as a necessary response to the changing risk landscape from structural changes in the business environment. Firms are transferring risk through financial instruments in order to reduce costs associated with financial distress, and to safeguard cash flow and thereby investment projects. However, they are also using novel risk transfer solutions to create value by lowering the cost of capital and to reduce earnings volatility. New covers will expand the scope of protection products by enlarging the boundaries of insurability and also the role of insurance in corporate risk management.