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INTEGRATED FINANCING OF RISKS GAINS GROUND

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Corporate treasurers are increasingly turning to the insurance market to cover risks that traditionally were hedged in the capital markets, in an ironic twist to the highly touted efforts of investment bankers to securitize insurance risks.

In July, Minneapolis-based Honeywell Inc. cut its costs by buying insurance coverage under an integrated risk financing program that will cover the company's currency losses.

Other corporations also are now looking to integrated risk products to cover anything from hog futures to interest rate variations, said Scott M. Sanderson, vp at J&H Marsh & McLennan Inc. in Minneapolis, who placed the Honeywell coverage. Because of their volatility, financial risks are more efficiently covered under an integrated program where there is a greater spread of risk.

"Some people call it the 'insurance-ization of the capital markets,' " he said.

The coverage of financial risks contrasts with the sometimes successful and other times futile attempts by investment bankers and insurers over the past few years to access the capital markets to provide financing for insurance risks.

The currency insurance is just one advantage of the integrated risk programs, said other experts.

Since their emergence over the past two years, integrated risk products have provided broader coverage, stable capacity, more efficient use of insurance, and significant cost savings to policyholders, they say.

The Honeywell program was placed on July 1 and covers property, liability, directors and officers liability, and the currency translation risk on foreign profits, said Thomas P. Seuntjens, a member of the treasury management team at Honeywell.

American International Group Inc. underwrites the coverage. Mr. Seuntjens declined to provide any financial details of the program.

The foreign exchange risk is significant, because 36% of Honeywell's $770 million in profits last year is derived from overseas operations, he said.

Previously, Honeywell bought separate foreign exchange hedges to cover the different currencies it worked with, Mr. Seuntjens said.

Now, by buying insurance for the risk, Honeywell has simpler, cheaper and more predictable coverage. Mr. Seuntjens would not disclose a percentage of savings attained through the integrated program, and noted that an exact direct cost comparison is difficult.

With currency hedges, "you had to look for opportune times to buy them, and that leaves it to chance or luck and somebody's judgment. This is much more systematic," Mr. Seuntjens said.

The inclusion of currency risks also helps broaden the risk base for the integrated insurance program, which helps to reduce the overall volatility of risks to Honeywell, he said.

Like most integrated coverages, Honeywell's has a single combined aggregate for all of the lines. Honeywell also has a reinstatement option should the aggregate limit be exhausted over the course of the 21/2-year term of the program. The program has a 21/2-year term to bring it into line with the company's financial year, Mr. Seuntjens said.

Although there is a dilution of coverage under a single aggregate program, the chances of the Honeywell's program being exhausted is a one in 10,000-year event, said Mr. Sanderson of J&H Marsh & McLennan.

"Yes, there is a loss of coverage under these programs, but you have to look at the probabilities," he said.

Also, Honeywell has additional catastrophe insurance programs purchased annually to back up the individual coverages under the integrated program, Mr. Sanderson said.

Honeywell has started off by covering currency risks under the program, but it is already considering including other risks that are not normally insured when it renews the coverage, said Mr. Seuntjens.

"There is no reason why we can't use it to cover interest rate swaps or commodity risks," he said.

Huntsman Corp. is considering including interest rate risks, price fluctuations and foreign exchange risks in its integrated risk program, said Lee Skidmore, assistant treasurer at the Salt Lake City-based chemical manufacturer with revenues in excess of $5 billion.

But already it is enjoying lower premiums and simplified coverage for its traditional risks through its integrated program, he said.

Huntsman has had an integrated program in place for 18 months to cover property, liability, mechanical breakdown, gradual pollution and employment practices liability, Mr. Skidmore said at a seminar sponsored by the Financial Executives Institute and J&H Marsh & McLennan in New York earlier this month.

Mr. Skidmore estimates that Huntsman has saved 30% in premiums over its previous program. And the number of insurers involved has been reduced to 15 from 40.

Also, the program makes it simpler to manage claims. Under Huntsman's previous program, for example, it had a claim after a power outage. The property insurer denied the claim, saying that it should be covered by the mechanical breakdown insurer, and the mechanical breakdown insurer said it should be covered by the property insurer.

"The claim has been delayed, and we are currently involved in litigation," he said.

Huntsman's new integrated policy eliminates that infighting among insurers, Mr. Skidmore said.

The policy also locks in capacity for the three-year term of the program, he said.

"We are a capacity buyer of property/casualty insurance. . . .We need to lock into capacity because of our insurance exposures, and if you are in a soft cycle why not lock in at the bottom of the cycle?" Mr. Skidmore said.

The integrated risk programs reduce premium costs in part because of the leverage that buyers achieve by approaching one or a few insurers with all of their exposures, said Bayard Dodge, vp at J&H Marsh & McLennan.

Under a traditional insurance program, "the individual underwriters price their individual products, and if the underwriters are in different companies, you can't gain any leverage through your premium volume," he said.

Also, integrated programs are more efficient because they make better use of the limits by covering all of the risks with an aggregate limit, Mr. Dodge said.

"It is very unlikely that you will use all of the limits that you buy" under a traditional program, he said.

So while one buys less coverage, one does not buy less coverage than is needed, Mr. Dodge said.

"Integrated risk financing contemplates a well-thought-out plan to buy less insurance," he said.

There also are savings on administrative costs because there are fewer insurers to deal with and, because the programs are usually purchased on a multiyear basis, many of the renewal costs are eliminated, Mr. Dodge said.

Integrated programs can cut 30% of the transfer costs of a traditional insurance program, he said.

Insurers also see some benefits from the programs, despite the reduction in premiums, said Dennis Kane, president of CIGNA Special Risk Facilities, a unit of CIGNA Corp.

"It provides for stronger relationships and it creates efficiencies in an inefficient business," Mr. Kane said.