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Tough exposures test risk managers

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Risk managers must be increasingly creative in seeking coverage solutions for exposures with potential losses that are so large or immeasurable that they are difficult to insure in the traditional markets.

The pharmaceutical and financial service industries in particular have major exposures that force risk managers at those companies to seek alternative risk financing solutions, risk managers said at an Assn. of Professional Insurance Women's panel discussion, "Surviving and Thriving in an Era of Creative Risk Financing," last month in New York.

The pharmaceutical industry faces risks as diverse as reputational risk, tort litigation and professional liability claims, said Diane Askwyth, senior director, risk management and insurance for Kenilworth, N.J.-based Schering-Plough Corp.

"Our risks are unusual and very specific to the pharmaceutical industry," she said. "Many of the risks aren't even insurable. Some are insurable only at very high catastrophic levels above jaw-dropping size deductibles."

For example, a key risk pharmaceutical companies face is the possibility of their prescription drug products causing injury or death. Even if only 1% of patients suffer side effects from a medication, a pharmaceutical company could face a situation similar to what Whitehouse Station, N.J.-based Merck & Co. Inc. has encountered with Vioxx, with Merck facing thousands of lawsuits alleging the anti-inflammatory drug caused heart problems or fatalities. "That's just a tremendous risk," she said.

The difficulty in insuring its risks was the reason Schering-Plough created a captive insurance company, Ms. Askwyth said. "We run a lot of expected losses though our captive because we frankly don't have a choice," she said. "We have to be the kings of alternative risk financing."

Another potential solution for difficult-to-insure exposures involves risk financing arrangements using the capital markets, although the structure of these arrangements is still developing, risk managers say.

Marlene Debel, a managing director with New York-based Merrill Lynch & Co. Inc., who is responsible for the firm's capital management and global insurance and risk groups, has spent a great deal of time exploring how to use the capital markets to cover risks. When a security is sold to an investor, though, the potential payoff must be clear, which is difficult to establish for certain risks and complicates the possibility of using capital markets to address those risks, she said.

Ms. Askwyth has explored the possibility of using the capital markets to address product liability risks, given that only about five insurance companies still write the risk for pharmaceutical companies and the most capacity generally available is about $250 million, but she has not seen an appetite for the risk. "The capital markets can not model product liability risks," she said. "And that's the scary one."

With various stakeholders considering the possibility of using the capital markets in risk financing arrangements, Ms. Debel said she would not be surprised to see products developing with the aim of using the capital markets to develop capacity that does not exist in the insurance market. "I think the market needs to evolve a bit before it becomes a good risk alternative," she said.

For risk managers today, it is critical that they understand the various operations of their company so that they can translate those operations into the language of risk and insurance, said Janice Ochenkowski, managing director at Chicago-based Jones Lang LaSalle Inc. This is important in not only finding the appropriate vehicles to manage risks, but in helping senior management understand and discuss the transfer or acceptance of risk, she said.

Many risk managers spend a great deal of time understanding insurance products, but risk managers have excellent resources in brokers and underwriters who understand the nuances of these products, Ms. Ochenkowski said. Instead, they should focus on understanding their company's operations so that they can raise the impact of risk management within the organization and be seen as having a vital role in the operation of the company, she said.

In addition to understanding the insurance market, risk managers expect their brokers to understand their business and what services they are expected to provide, Ms. Ochenkowski said. "If we're clear in telling you what we expect from you, then you need to be honest with us about whether you can deliver that or not," she said. "I think communication needs to be open and honest on both sides."