Also known as ART, an alternative risk transfer is a means of managing the degree of risk or potential for loss that is taken on by various types of entities by transferring a portion of that risk to another entity. To a degree, alternative risk transfer is somewhat like the use of traditional insurance or reinsurance methods, although these risk management tools are typically considered outside the scope of ART. For this reason, methods and strategies that do fall into this category are often used in addition to traditional insurance as a means of protecting the insured party from financial loss.
The concept of alternative risk transfer began to develop in the early 1970’s, when concerns about the limits of insurance and reinsurance coverage began to be manifest within the business world. Simply put, the amount of risk involved with a given situation would be greater than the amount of insurance coverage that could be obtained. As a result, businesses and other types of entities began to look for additional ways to protect themselves from potential losses that would work in conjunction with available insurance coverage and provide a greater degree of protection overall.
One approach to alternative risk transfer involves the creation of what is known as captive insurance companies. These firms are often organized by traditional insurance and reinsurance providers, but are structured to allow the premiums received to be invested in untraditional ways. At times, the firms may also actually purchase additional coverage from third parties, which helps to transfer some of the risk from both the parent and the captive, while still providing the insured party with the greatest degree of protection possible.
Other methods may include taking on investments that help to provide protection in the event of some type of major event. One example of this approach is the purchase of catastrophe bonds, which are bond issues that can be called and converted into cash when a covered natural or other type of disaster takes place. Here, the goal is to use the proceeds of the bond to manage losses not covered by more traditional types of insurance, while not impacting the amount of compensation that is received from those traditional policies.
Newer tools for use in alternative risk transfer strategies continue to emerge, including investments like weather derivatives, which can provide some level of financial compensation when the insured party sustains damages as the result of specified weather conditions. As a means of securing additional protection from losses, the concept of ART is likely to keep evolving as the costs of recovering from unfortunate events continues to increase.
