The ART of Transferring Risk

From the University of Chicago: ''alternative risk transfers'' blur distinctions between insurance companies and banks.

Once upon a time, in the not-so-distant past, a finance chief could tell the difference between an insurance policy and a derivative contract.

It was really a no-brainer. An insurance policy was a signed agreement under which your company paid a premium. In exchange, the company got to transfer some of its risks — like fires or class-action lawsuits — to a property/casualty insurance company.

A derivative, on the other hand, was a security you bought from a banker or a dealer to hedge corporate financial risks or to bet on a good investment return.

In recent years, however, distinctions between the commercial insurance industry and the capital markets have blurred. Both camps are routinely lumped under the adroitly coined rubric of ART, short for “alternative risk transfer.” The only common element? Risks are covered in nontraditional ways.

Indeed, it’s hard to tell the players without a scorecard. Looking like investment bankers, some insurers and reinsurers now help clients issue securities — not necessarily to raise capital for a project, say, but to cover the client’s risks. Carriers are also venturing into what was once exclusively capital-markets terrain by serving up hedging features in some P/C products.

For their part, some bankers can easily be mistaken for insurance executives. Like insurers, they take part in deals involving captive insurance companies — perhaps the oldest part of the ART scene. Further, capital-markets mainstays like Lehman Brothers and Goldman Sachs are players in the Bermuda reinsurance market.

Navigating such shifting — and often offshore — waters can be tough for CFOs with risks to cover and capital to protect. But if they’re equipped with a coherent way to shop the ART market, they can find ways to cut risk-transfer costs, says Christopher Culp, who teaches “Alternative Risk Transfer: The Convergence of Corporate Finance and Risk Management,” an executive education course at the University of Chicago’s Graduate School of Business.

What finance executives need is a methodical way to sort through the mounting numbers of alternative-risk offerings, according to Culp, an adjunct professor of finance who often consults for participants in the insurance and derivatives industries. While selecting alternative risk coverage might involve dicier decisions than choosing a breakfast cereal in a supermarket, he suggests, similar principles apply.

In the latter case, the professor asks, “wouldn’t it be great if we had a more systematic way of knowing which box to go to?”

Between RAROC and a Hard Place

To be sure, the observation that corporate finance and risk management are melding is nothing new. Culp, however, says contends that his course has gained become especially important just now.

University administrators apparently agree: They began offering a version of the class as part of Chicago’s regular MBA program for the first time last autumn and will offer two sections of it this fall. (Culp and a Swiss Re executive have recently taught similar courses open only to the reinsurer’s client companies and its own executives, and Chicago will do the same for other interested companies.)


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