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CAPTIVES CAN HELP GET HEDGES IN A ROW

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BURLINGTON, Vt.-Although many companies today have numerous hedging activities taking place across the organization, relatively few have taken steps to integrate those efforts.

An organization-wide commitment to a risk management approach that combines financial and hazard risks is a key attribute of the ideal candidate for a financially integrated risk program, said Carolyn P. Helbling, senior manager of Swiss Re New Markets, a unit of Swiss Reinsurance Co. in New York. However, she noted, "Amazingly, this is not the case even in many of the major Fortune 500 companies."

Moderating and coordinating a session on integrated risk programs at the Vermont Captive Insurance Assn.'s annual conference in Burlington, Vt., Aug. 13, Ms. Helbling discussed the advantages that such approaches can offer, as well as setting out other qualities of companies that are most likely to benefit from them.

In addition to that risk management commitment, the companies best suited for an integrated program also typically are sensitive to volatility in profits, favoring stability in earnings and shareholder value over spectacular growth one year and stagnation the next.

They also have a strong liaison between the treasury and insurance functions and are ready to challenge traditional thinking about their insurance programs and look at a multiyear, multiline approach.

Ideal candidates should be seeking a long-term commitment of a financially strong provider of net capacity behind the company's captive or alongside the key fronting insurer, should be able to retain considerable risk on a basket approach capturing the expected frequency losses and should have comprehensive and significant loss experience.

Finally, the ideal company for an integrated program must involve its accounting and tax people in the process.

Companies meeting those conditions can craft programs bringing a number of exposures both insurable and finan cial together in a single basket aggregate, said Ms. Helbling.

She added, "These programs become tremendously efficient of course because you are reducing the overall amount of coverage you're buying."

While such programs can't be put together overnight, ultimately they can provide various other benefits in addition to lower costs, including stabilizing coverage terms and conditions, simplifying administrative procedures, optimizing the use of the company's captive, capping the company's total cost of risk, allowing for a flexible program design and allowing the company to secure net capacity from top-rated providers.

That has been the case at Mountain View, Calif.-based Sun Microsystems Inc., where such a program, among other things, has allowed the company to pare a program with approximately 50 different insurance policies down to a program with a single aggregate policy and two directors and officers policies, according to Carol Harrington, the company's director of risk management.

The three-year program combines property/casualty and financial exposures in a single policy with $600 million in aggregate coverage above an initial layer of coverage provided by Sun's captive.

"The reason Sun Microsystems went forward with this exciting new enterprise is we felt that the very traditional way of handling our insurance program separately from the treasury operation and buying off-the-shelf products was not the way to go in the future," Ms. Harrington said.

Ms. Harrington noted that the boundaries of such programs "are whatever you make them."

She presented a long-term "year-five" captive plan that involves bringing harder-to-insure risks-such as earthquake and flood perils, environmental liability, product recall, benefits-related risks and commercial risks like product warranty, credit and interest rate risk-into the program.

"The captive insurance year-five strategy is what I really needed to sell to these partners that we are going forward with," she said.

"You need to push the model and say, 'This is not a per line, per risk coverage' and the capacity will increase overall," Ms. Harrington said. "It's phenomenal what the excess carriers are willing to blend into the program."

Ms. Harrington said the process of crafting an integrated program can take six months to a year and involves such steps as broker selection, discussions with top management, assessing the company's risk tolerance, developing a retention strategy, gathering exposure and underwriting data and conducting actuarial studies and developing loss projections before actually going to the market to obtain quotes.

Another panelist, Arlene Corsetti, managing director at J&H Marsh & McLennan Inc. in San Francisco, stressed the importance of conducting a strategic risk assessment as part of developing an integrated risk program.

Such an assessment is a quantitative financial and qualitative analysis of risk across all operations, Ms. Corsetti said.

The analysis can be assembled in stages. "You can start very simply and put more and more risk into the process in your evaluation," she said.

The process is important because of the need to know how to set limits in multiple risk scenarios and the fact that integrated programs increase the focus on a total cost of risk, she said.

Essentially the analysis involves creating a matrix incorporating the organization's categories at risk, the hazards faced and the potential consequences of those hazards occurring.

Once the high-risk scenarios are identified and quantified, the analysis moves toward determining the probability of occurrence and the probability of liability or responsibility. "The fact that a risk occurs doesn't mean that you're really going to have to pay out," Ms. Corsetti said.