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Integrated Risk Policies: Program Design and Pricing Strategies

This presentation from the Centre Group discusses integrated risk policies that combine traditional insurance with alternative risk management strategies, such as surety bonds and corporate guarantees. It explores the definitions, examples, and structure of integrated risk, highlighting both advantages and disadvantages. Key features include how coverage is provided, the importance of stabilizing financial statements, and strategies for achieving economies of scale through holistically managed risks. Case studies demonstrate real-world applications, showcasing practical implementation in multinational environments.

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Integrated Risk Policies: Program Design and Pricing Strategies

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  1. Program Design and Pricing Options for Integrated Risk Policies Will Dove, Centre Group Casualty Actuarial SocietyFinancial Risk Management SeminarApril 12-13, 1999 – Denver, CO

  2. out of our minds What is Integrated Risk? • Single contract covering both traditional insurance risks and other risks • Insurance policy • Surety bond • Corporate guarantee • Put option • Contingent equity/liquidity contract

  3. out of our minds What is Integrated Risk? • Examples of other risks • Business risk • Credit risk • Liquidity risk • Market risk • Foreign exchange rates • Commodity prices • Asset prices

  4. out of our minds What is Integrated Risk? • How is coverage provided? • Coverage part • Indexed retention or limit • Investment credit to experience account

  5. out of our minds Coverage Trigger • Accounting: goal is to stabilize accounting results (income statement, balance sheet) • Economic/Cash Flow: goal is to stabilize future cash flows/asset values

  6. out of our minds Advantages of Integrated Risk • Can allow customer to purchase less coverage on more flexible terms • Single limit available to cover a broad collection of risks can be superior to a collection of smaller limits each covering a single risks • Administrative efficiency: fewer pieces of paper to manage • Can facilitate transactions, reduce equity requirements and/or cost of debt in some circumstances

  7. out of our minds Disadvantages of Integrated Risk • Soft insurance markets can provide insurance at less than cost for some period of time • Contracts must be individually structured: lot of work, can involve significant costs • May require changes to traditional risk management practices

  8. out of our minds How can economies be achieved? • Total risk management • Insurer and customer must take a holistic risk management approach instead of stapling together multiple policies that are separately priced • Customer • Must integrate risk management and other financial management functions (e.g. treasury) to evaluate pricing and coverage terms • Insurer

  9. out of our minds How can economies be achieved? • Insurer • Must integrate underwriting/pricing/reserving for insurance and other risks: risk premium example • Assume that risk premium is proportional to variance of losses • Let A denote traditional insurance losses, B denote other losses covered by an integrated contract • Expected losses E(A+B)=E(A)+E(B) • Risk premium kVar(A+B)=k[Var(A)+Var(B)+2Cov(A,B)] • If Cov(A,B)<0 then insurer can pass benefit on to the customer through reduced risk premium only if it retains both risks A and B on the same balance sheet • Insurer must consider correlation of new contract with its existing risk portfolio as part of the underwriting process

  10. out of our minds Accounting Issues • FAS 133: Hedge vs investment vs insurance accounting

  11. out of our minds Examples of Integrated Risk Transactions • Basket Aggregate program for US-based multinational: multiple property and casualty coverage, foreign exchange risks • USAir: Collateral substitution program covering WC loss payments contingent on airline’s credit worthiness and asset value risk • Lan Chile: Credit enhancement of notes supported by credit card receivables • Canadian Airlines: Senior debt put option combining credit risk and asset value risk

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