Transcript No Slide Title

Finite Insurance: Limiting
Transactional Risk
World Services Group
May 7, 2004
ADVANCING
CORPORATE
STRATEGY
THROUGH
ALTERNATIVE
SOLUTIONS
presented by:
Todd Cunningham
Assistant Vice President, AIG Risk Finance
Agenda
• Introduction
• Alternative Risk Financing Techniques
– Loss Portfolio Transfers
– Structured Insurance Solutions
• Scenarios
ADVANCING
CORPORATE
STRATEGY
THROUGH
ALTERNATIVE
SOLUTIONS
Current Situation
• Insurance Market
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Higher retention levels
Loss of certain key coverages
Layers with rates on line of 20% or more
Single-year basis only
• Industries Impacted
ADVANCING
CORPORATE
STRATEGY
THROUGH
ALTERNATIVE
SOLUTIONS
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Healthcare
Construction
Financial Services
Manufacturing
Alternative Risk Financing Techniques
• Retrospective Exposures
– Loss Portfolio Transfers
• Primary casualty liabilities
• Exotic liabilities (asbestos, product liability)
• Captive run-off
• Prospective Exposures
– Finite Products - structured insurance solutions
– Structured Hedging
ADVANCING
CORPORATE
STRATEGY
THROUGH
ALTERNATIVE
SOLUTIONS
• Structured derivative and insurance transactions
• Financial risks
Loss Portfolio Transfers
• The assumption of liabilities, typically developed
over a substantial period of time (retrospective
exposures)
• May cap potentially devastating balance sheet
exposures related to prior events
• May create a more stable financial environment for
the companies involved
• Also known as a “liability buyout”
ADVANCING
CORPORATE
STRATEGY
THROUGH
ALTERNATIVE
SOLUTIONS
Loss Portfolio Transfers
- Benefits -
• Eliminate operational obstacles, advance growth
• Address volatility of accrued liabilities by
transferring risks to an insurer
• Diminish negative impact to future profits
• Release security behind existing insurance
• May accelerate tax deduction of the liabilities
• Manage cash flow with premium finance
• Facilitate merger, acquisition, or divestiture
ADVANCING
CORPORATE
STRATEGY
THROUGH
ALTERNATIVE
SOLUTIONS
Loss Portfolio Transfers
- Typical Risks -
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ADVANCING
CORPORATE
STRATEGY
THROUGH
ALTERNATIVE
SOLUTIONS
Medical malpractice & hospital professional liabilities
Warranty liabilities
Merger & Acquisition-related risks
Asbestos and occupational disease liabilities
Primary retentions of WC, GL, AL
Captive insurance companies
Public entity-related liabilities
Intellectual property (patent, copyright infringement)
Loss Portfolio Transfers
- Pricing -
• Assumes future liability to an aggregate limit
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ADVANCING
CORPORATE
STRATEGY
THROUGH
ALTERNATIVE
SOLUTIONS
Reserve estimate (to ultimate losses)
Payout pattern
Discount @ Treasury strip rates
Insurer profit margin
Claims handling costs
Intermediary compensation
Loss Portfolio Transfer
Insurance Co.
ABC Inc.
Self Insured
W.C. Reserves
$55MM
Premium $50MM
Policy Limit $75MM
ADVANCING
CORPORATE
STRATEGY
THROUGH
ALTERNATIVE
SOLUTIONS
Assumes future
liab. to agg. limit
Pricing Developed:
•Reserve Est.
•Payout Profile
•Discount
•Claims
Handling
Loss Portfolio Transfers
• Facts
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Client - Self insured years 1996 - 2002
Accrued Liability - $55 million
Deferred Tax Asset - $18.7 million
Net Loss - $36.3 million
• Solution
– Policy Limit - $75 million
– Premium- $50 million
– Tax benefit- $17 million
• Benefit
ADVANCING
CORPORATE
STRATEGY
THROUGH
ALTERNATIVE
SOLUTIONS
– $3.3 million in net cash
– $20 million in additional insurance protection
• (to cover under-valuation of accrued liability)
Structured Insurance Solutions
• Insurance solutions which often combine
insurance and capital market techniques
• May contain:
– a component of funding by client,
– structured policy limits, and
– a provision for insured to benefit from favorable loss
experience
• Highly customized programs to protect insureds
from financial, strategic or operational risks
ADVANCING
CORPORATE
STRATEGY
THROUGH
ALTERNATIVE
SOLUTIONS
Structured Insurance Solutions
- Characteristics -
• Multi year policy term
• Customized limits of liability
• Potential for sharing of favorable loss experience
(experience accounts)
• Coverage for uninsurable or difficult to insure risks
• Customized structures
ADVANCING
CORPORATE
STRATEGY
THROUGH
ALTERNATIVE
SOLUTIONS
Structured Insurance Solutions
- Risks -
• Difficult to insure risks
– Construction defects - Medical/hospital professional
– Product liability
- Casualty and property
– Financial lines
- Residual Value
• Capacity constrained risks
– Product recall, patent infringement, trade credit
• Perceived ‘mispriced” risks
• Capital Market-based exposures
• Unique risks
ADVANCING
CORPORATE
STRATEGY
THROUGH
ALTERNATIVE
SOLUTIONS
Structured Insurance Solutions
- Benefits -
• Quantify maximum losses for a period of time
• Lock in multi-year pricing (insulate market fluctuations)
• Address volatility of potential liabilities that affect balance
sheet
• Stabilize cash flows
• Maximize tax efficiencies
• Benefit financially from favorable loss experience
• Provide evidence of insurance coverage
• Facilitate an underlying transaction
ADVANCING
CORPORATE
STRATEGY
THROUGH
ALTERNATIVE
SOLUTIONS
Structured Insurance Solutions
- Components -
15 M
Risk Transfer
Accumulated Interest
20 M
Accumulated Premium
Accumulated
Experience Balance
ADVANCING
S.I.R.
CORPORATE
STRATEGY
THROUGH
ALTERNATIVE
SOLUTIONS
5M
Yr 1
Yr 2
Yr 3
Structured Insurance Solutions
- Underwriting Criteria -
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ADVANCING
CORPORATE
STRATEGY
THROUGH
ALTERNATIVE
SOLUTIONS
Identify client objectives/motivation
Conduct preliminary risk assessment
Develop underwriting data
Preliminary cash analysis
Establish timing objective
Structured Insurance Solutions
- Pricing Considerations -
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ADVANCING
CORPORATE
STRATEGY
THROUGH
ALTERNATIVE
SOLUTIONS
Analysis of risk
Loss payout profile
PV costs at current market interest rates
Risk Premium
Profit and administration
Applicable premium taxes
Term
Administration costs
Client Profile
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Difficult-to-insure, long-tail exposures
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THROUGH
ALTERNATIVE
SOLUTIONS
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Sufficient liquidity to address the issue
Minimum target premium of $5M
Wants a solution reflective of a specific risk profile
Leveraged risk transfer is not the primary motivation
Has a risk that can be sufficiently analyzed and priced
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Evidence of insurance required
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Senior decision maker involved
CORPORATE
STRATEGY

Loss data available
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ADVANCING

Patent Infringement
Trade Credit & Political Risk
Property
Product Liability
Structured solution desired
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Liquidity
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Medical Malpractice
Financial Lines (E&O, D&O)
Casualty
Warranty
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Senior decision maker seeking to resolve a material problem in a
defined time-frame
Scenarios
• Construction
– Construction Defect
• Healthcare
– Managed Care E&O
• Manufacturing
– Product Recall
• Technology
– Shock Loss Protection
• Other
ADVANCING
CORPORATE
STRATEGY
THROUGH
ALTERNATIVE
SOLUTIONS
– Captive Purchase
– Asbestos Liability
Construction Defect Risk
Situation
Construction
Solution
A publicly traded U.S. homebuilder selling
over 2,500 homes annually, averaging
$300,000 each, had received a number of
GL quotes which were expensive given its
good loss history. The market was
demonstrating concern for the
construction defect exposure in many of
the states in which the client builds.
A five-year GL insurance program
with limits of $5,000,000 per
occurrence excess a $500,000 per
occurrence retention. Aggregate
policy limits are $10,000,000.
Policy Premium is $7,500,000.
Benefits
ADVANCING
CORPORATE
STRATEGY
• Policy form modeled after standard ISO General Liability Policy as required by
insured.
• Client is able to insulate itself form vagaries of current insurance market cycle.
• Tax efficient solution.
THROUGH
ALTERNATIVE
SOLUTIONS
1
Managed Care E&O
Situation
Healthcare
Solution
A regional HMO was seeking alternatives
to the traditional insurance market, citing
an increase in renewal rates. The client
was interested in an insurance program in
which they could benefit from their
positive loss performance while cutting
back on current insurance costs. Client
also has to show evidence of insurance.
The three-year policy
limits are $40,000,000
per claim with a
$55,000,000 policy
period aggregate.
Benefits
ADVANCING
CORPORATE
STRATEGY
THROUGH
ALTERNATIVE
SOLUTIONS
• Provided multiple-year coverage.
• Transaction provides client with a tax-efficient structured insurance solution.
• Program enables client to satisfy its certificate of insurance requirement.
Product Recall
Situation
Manufacturing
An auto parts manufacturer
faced large volatility in
earnings per share due to its
product recall exposure.
Solution
An insurance program
covering product recall,
product extortion and
warranty exposures over a
multi-year term.
Benefits
• Allowed insured to fund the cost of recalls over several years.
• Transferred volatility risk.
ADVANCING
CORPORATE
STRATEGY
THROUGH
ALTERNATIVE
SOLUTIONS
• Tax efficient solution.
• Provided coverage that was otherwise unavailable in the market.
Shock Loss Protection
Situation
Technology
ADVANCING
CORPORATE
STRATEGY
THROUGH
ALTERNATIVE
SOLUTIONS
A software company may
have substantial exposures
to future litigation for
copyright infringement.
Solution
An insurance policy that
provided protection against
multiple perils that had the
potential to adversely affect
earnings. The policy provided
this protection for 10 years.
Benefits
• Potential to minimize exposure to copyright infringement lawsuits over the
long term.
• Client initially retains claims control, which enables it to defend claims in the
manner it deems appropriate.
• A tax efficient structure.
• Substantial policy limits that were otherwise unavailable.
Captive Purchase
Situation
Other
A UK entity inherited a
redundant reinsurance captive
through a recent M&A
transaction.
Solution
Three Steps:
• A sale of the captive to an unrelated
3rd party.
• A buyout of the insurable risks in the
captive.
Management wished to shut it
down in the most tax effective
manner.
• A closeout of the captive by the
unrelated 3rd party.
Benefits
ADVANCING
• By arranging the purchase of the outstanding shares of the captive, it was completely
removed from the client’s balance sheet.
CORPORATE
• Client was able to record its gain on its investment in the captive.
STRATEGY
THROUGH
ALTERNATIVE
SOLUTIONS
• Client fully transferred all potential future liabilities from the captive (through the 3rd
party) to the insurer.
Asbestos Liability
Situation
Other
Solution
Client faced claims resulting from the
past use of asbestos in its products.
Uncertainty about this liability increased
on the bankruptcy filing of another
asbestos defendant.
Solution enabled client to fund periodic
uninsured or underinsured portions of
their existing insurance, as well as a
significant limit to cover liability that
might exceed the existing coverage.
Client was forced to make a reasonable
estimate of the portion of its ultimate
liability not covered by their existing
insurance.
If cumulative paid claims exceeded a
fixed sum, insurer provided a significant
amount of risk transfer.
Benefits
ADVANCING
CORPORATE
STRATEGY
THROUGH
ALTERNATIVE
SOLUTIONS
• Covered claims paid for the next 50 years, or until the limit of liability is
exhausted, or policy is commuted.
• Provided annual policy limits that reimbursed client for paid claims not covered
by existing insurance.
• Ring-fenced the material liability and potential source of future earnings volatility.
• Share in favorable loss experience.
Disclaimer
This presentation is for illustrative purposes only and should not be
construed as an attempt to define any of the terms and conditions
regarding a possible issuance of coverage. Clients are advised to make
an independent review and reach their own conclusions regarding the
economic benefits and risks of any proposed transaction, as well as the
legal, regulatory, credit, tax and accounting aspects of a transaction as it
relates to their particular circumstances. This presentation does not
constitute an offer to sell coverage of the type generally described herein.
Insurance provided by member companies of American International
Group, Inc.
ADVANCING
CORPORATE
STRATEGY
THROUGH
ALTERNATIVE
SOLUTIONS
08/2003