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CHICAGO -- If integrated risk financing approaches are to take hold, insurance buyers must view them as part of a broader approach to managing risk, rather than just another insurance product.
According to panelists at the Eighth Annual Insurance Executive Forum of the Katie Insurance School of Illinois State University, the first step toward integrated risk financing programs is for all those dealing with the diverse risks an organization faces to take a common approach to managing those risks.
At the same time, if the insurance industry is to provide the best risk financing solutions to its clients, it must promote holistic rather than individual product strategies, said John G. Gantz Jr., executive vp at Swiss Reinsurance America in New York and one of the participants in the discussion earlier this month in Chicago.
Discussing his company's efforts to craft a multiyear/multiline approach, Jeffrey M. Sandburg, director of risk management at Chicago-based Morton International Inc., said, "I think the first question that a risk manager has to answer is, 'Does the concept make sense?' "
"Intuitively and logically, I think it makes a lot of sense," Mr. Sandburg said.
The next step is to look at how the organization is handling its risk and who is handling it. While typically the risk manager handles many of the organization's exposures, other people, such as treasury, the purchasing department or operations, also are handling risk, Mr. Sandburg noted.
"The key thought in going forward in the program is you have several different disciplines working together in divergent ways to control corporate assets and preserve shareholder equity," he said.
The multiyear/multiline programs then look to take those various risks and place them in what Mr. Gantz said may "simplistically" be described as a basket aggregate retention with a single limit of risk transfer above the retained layer.
"Typically these are the hazard risks that would be covered by traditional insurance," Mr. Gantz said. "But increasingly now we're moving away from traditional risks," with the integrated programs beginning to take in operational and financial risks such as foreign exchange risk or interest rate risk.
Another key element of bringing those non-traditional risks into the integrated insurance package involves getting everyone in the organization to agree on what constitutes an acceptable level of risk.
To illustrate how widely that risk appetite can vary within an organization, David C. Mocklow, director at Aon Capital Markets in Chicago, cited a client he met with recently who bought insurance down to a $5,000 retention, while the company's treasury department had a $25 million risk tolerance.
So the first step is to help the organization recognize inconsistency in its approach to risk, Mr. Mocklow said. Next is to develop a common approach and then finally to find the products or risk transfer solutions that can help them implement that concept.
As for the benefits of taking an integrated risk financing approach, E. Randall Clouser, executive vp at Zurich-American Insurance Group in Schaumburg, Ill., said, "The one thing we can say it is not is 'Buy three lines of business, get two free.' "
Instead, Mr. Clouser said, the advantages are based on two concepts, the first being portfolio theory.
Looking at risks as part of a broader portfolio rather than individually diversifies exposures, promoting more predictable risk-cost assumptions that are probably lower than the sum of the costs of the risks considered individually.
In turn, that allows an organization to manage its retention strategically and possibly raise it, Mr. Clouser said.
That leads to the second key concept, efficiencies achieved by strategically managing retentions -- such as through multiyear/multiline coverage -- thereby reducing premiums.
In the process, the risk manager is freed to "manage risk and not manage insurance policies," Mr. Clouser said, and some frictional costs may be squeezed out of the process by virtue of avoiding annual renewals.
Despite the potential advantages of an integrated risk approach, Mr. Clouser said that for now its development is being driven by the insurers, reinsurers and brokers, rather than by the policyholders.
While some client companies are coming forward with opportunities to craft multiyear/multiline programs, "I think largely we are driving this market," he said.
"Risk managers are using (traditional) insurance to finance insurance risk very, very efficiently," Mr. Clouser said, while treasury departments are proving successful at using various financial tools to hedge their risks.
And from a policyholder's perspective, Mr. Sandburg noted that developing an integrated program is a very time-consuming process, and many risk management departments don't have enough staff to devote to the task.
"I think time can be a real deterrent to looking at a holistic approach," he said.
Mr. Gantz said: "I think the reality is that we're in a period of education. But what we're really doing is changing the way that we partner with our clients."
But Tobey J. Russ, president of American International Group Inc.'s Risk Finance Division in New York, said he thinks integrated programs will become commonplace in the near future.
"I think certainly within 10 years we're going to see these programs be much more the norm. You're going to look back and wonder what all the fuss was about," he said.
In addition, he said, "I think you're going to see a lot more capital market participation going forward, not just in catastrophe bonds but in areas like this."
Insurance companies, Mr. Russ suggested, will become less "warehousers of risk" and instead "packagers of risk," moving those exposures into the capital markets.
And because of those changes, Mr. Sandburg said he thinks the risk management function itself will change.
Rather than fearing that change, Mr. Russ said, risk managers can prepare for it.
"I think if you're at a corporation and you're a risk manager, one of the things you should consider is rotating into the financial side of the operation," he said. "Likewise, finance people should rotate into risk management for a meaningful period of time."
And because of the programs' complexity, whether from the seller or buyer side of the integrated risk financing transaction, Mr. Clouser said: "I also think there's not going to be one person who's going to be able to understand all aspects of these transactions with the depth necessary. We have to team for expertise."
Kathryn J. McIntyre, publisher and editorial director of Business Insurance, moderated the Katie School's annual executive forum.