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How to Optimize Total Cost of Risk in a Volatile Casualty Market

Retaining more risk is a common choice when casualty insurance prices are high, but it is important to be strategic and thoughtful in these decisions. Now is the right time for risk managers be proactive by considering alternative placement strategies to help control and improve their risk outcomes.


The North American casualty insurance marketplace has been in the throes of its hardest market in many years – a “perfect storm” of increased pricing and shrinking capacity across most lines of business. It’s led to immense pressure for risk managers, who have experienced favorable conditions for more than a decade, but now face headwinds with challenging insurance renewals.

The COVID-19 pandemic has further compounded hardening marketing conditions. While we are seeing some signs of improvement and increased competition in the market in early 2021, the casualty marketplace is not expected to turn “soft” in 2021. Of note:

  • Rates continue to climb across most lines, but especially in excess casualty where more than $400 million in capacity has disappeared from the marketplace since 2018.[1]
  • Many organizations have reduced exposures due to slowdowns in consumer behavior and global economic conditions.  This exacerbates pressure on rates, with carriers increasing premium to maintain revenue.
  • Casualty carriers continue to be pressured by litigation and high “nuclear” verdicts.
  • Extremely low interest rates put additional pressure on casualty markets due to the “long-tail” nature of Workers’ Compensation and other lines. 

Gaining a sound understanding of your casualty program’s total cost of risk (TCOR) is critical to help you proactively manage your position while seeking continuous improvement in TCOR in a hard market. While there is no “silver bullet” in this marketplace, deploying a multi-pronged effort to reduce loss costs including risk control, effective claims and legal management, and actuarial and risk modeling, is more essential than ever as loss costs still comprise more than 70 percent of TCOR for most large North American organizations.   

 

Alternative Placement Ideas and Strategies

Now is the right time to be proactive by considering alternative placement ideas and strategies to help control and improve your risk outcome. Retaining more risk is a common choice when insurance prices are high, but it is important to be strategic and thoughtful in these decisions to make sure the agreed risk assumption is an informed decision for the organization and its key stakeholders. The use of best-in-class data and analytic resources will help you understand smart spending of capital in frequency layers versus excess layers and where to retain your risk. Whether via a quota share or excess layer, consider the optimal strategy to retain risk that will have the least impact on your operations and also provide a healthy balance between risk transfer and retention. Considerations may include:

  1. In the decades-long soft market it was a competitive strategy to complete risk transfer layers at 100 percent coverage and to very high limits. In today’s market, it may be wise to consider a program with risk retained in portions of the tower where risk transfer is not feasible or cost effective.
  2. Similarly, total limits should be examined in the context of multiple variable benchmarking, not just with industry “peers” whose exposures may be quite different.  Probability of loss in excess layers can also be considered so the Board can evaluate to what confidence level insurance should be purchased.
  3. What is your organization’s cost of capital?  While insurance has become more expensive, it is likely to still be a better use of “contingent capital” for higher risk transfer layers over reserving funds for a catastrophic or “black swan” event.
  4. There are multiple possibilities to assume more risk in the frequency or “working” layers where premium savings may be quite significant. These may involve the use of captives, whether wholly owned or segregated cell vehicles but many strategies do not require a captive. These may include quota share or increased layer risk assumption, corridor retentions, aggregate stop loss protection, multi-year risk financing, or other strategies. 

Deploying a captive may make it easier to access reinsurance capital to increase optionality with front-line insurance carriers to create efficiencies. An important consideration not to be overlooked when increasing risk retention are the contractual or compliance requirements for evidence of insurance for financial responsibility. 

 

Case Study: Alternative Risk Financing

Here’s one example of how a large organization, with equally large and complex casualty exposures, saved significant premium dollars and managed its total cost of risk through an alternative risk financing strategy. The client company was confronted with limited marketplace interest on its excess casualty program despite excellent loss experience. In particular, its lead umbrella for the $10 million in excess of $5 million layer was prohibitively expensive.

The company entered into a well-designed 3-year program with an alternative risk market that builds a loss fund that is impacted when there are claims in the layer. The cost profile over three years changes dramatically whether or not there are claims. This effective strategy cuts the organization’s costs in half in years where there are no claims, but even if there are claims, the costs are similar to what the traditional insurance approach would have been.

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In this volatile casualty market, it is important to have multiple strategies to consider – plans that can help you drive your renewal process and gain more control in the market.  To be more strategic, getting an early jump on your renewal process with thorough and accurate marketing data as well as thoughtful, bespoke analytics for your stakeholders will help pave the way to success.


[1] Challenging Headwinds in the Excess Casualty Market