With capacity under pressure in the property market, it may be necessary to consider an alternative structure to cover risk. Matt James, client director and head of education at Aon, explains how they work and the potential procurement issues.
Capacity is an issue in the hard market, with some large property risks struggling to find an insurer willing to provide cover. Using an alternative structure, where the risk is spread across two or more carriers, is an option, but it brings its own challenges. For property risks affected, typically those with loss limits above £50m, there are two structures that may be suitable – scheduling and layering. Understanding how they work, and the challenges they can raise for procurement, is essential.
Scheduling
With this, more than one insurer agrees to take a share of capacity and, in the event of a loss, they will each pay a corresponding share of the claim.
Scheduling example - Local authority Z requires a loss limit of £100m per event for its property risk. This is scheduled across three insurers, with insurer A providing cover for 50% of the loss limit; insurer B covering 30% of it; and insurer C taking the remaining 20%. An escape of water claim for £400,000 is received. This is split between the three insurers, with A paying £200,000; B £120,000; and C £80,000.
The terms and conditions of cover, as well as the required premium, are set by the ‘lead’ insurer (the insurer who is deploying the largest share of capacity) – in this example insurer A – and then agreed by the other insurers. Upon payment of premium, each insurer will receive their proportion of the total premium.
If the premium cannot by agreed by the other insurers, negotiation takes place to find a premium that is acceptable to all. If this is not possible, insurers may withdraw from the schedule or agree to increase their capacity share in order to lead with their terms.
If follow markets cannot agree the terms and conditions of the lead insurer, but nevertheless will write a share of capacity at their own terms, this is referred to as a ‘split-slip’. While not the preferred option, for some placements it is not possible to align capacity markets to the same premium, terms and conditions of cover. As you can imagine claims handling and indemnity payments are more complex when different insurers apply their own terms and conditions.
Layering
Again, capacity is provided by more than one insurer but with this, claims only fall to follow insurers when the loss exceeds the value of the lower layers.
Layering example - Local authority X requires a loss limit of £200m per event for its property risk. Insurer A agrees to provide a primary layer of £100m on a 100% basis while insurer B provides £100m in excess of the underlying layer to make up the full £200m of cover. A fire claim for £120m is received. The first £100m is covered by insurer A, with insurer B picking up the other £20m.
With layering, each insurer will set their own terms and conditions and premium. Typically, the insurer providing the primary layer will charge a higher premium to reflect the greater exposure they have to claims.
Tender challenges
Both approaches offer organisations greater flexibility around insuring a risk and, in the current market, may be the only way to cover larger risks. But, while they’re already used in the commercial and corporate markets, there are obstacles that present challenges for public sector organisations.
As both approaches involve an element of information sharing, which is not permitted in a formal tender, there can be compliance issues. Where a tender is perceived as unfair, there is a risk of a legal challenge, which can be time-consuming and costly.
This leaves public sector organisations in a difficult spot, with the tender process potentially preventing them from accessing the most competitive cover. Although what’s possible will depend on the procurement rules in place at the organisation, there may be ways to access these alternative structures without breaching formal tender rules:
- Invite bids for capacity and/or full limit and leave markets to decide how they will respond
Explain clearly in the tender specification that the contracting authority is seeking bids for a specified loss limit but requesting respondents to confirm the capacity they can deploy which will be evaluated.
We suggest that organisations invite bidders to state whether they will offer primary lead capacity, primary follow capacity or the full loss limit. The tender should also clearly specify, where capacity bids are entered, which party will complete the required capacity behind lead markets.
The cleanest solution is for the authority’s broker to ‘fill’ the capacity requirements by identifying markets who can follow the lead terms from the tender process. But the important thing is to ensure that the tender document identifies this additional step, to ensure that all potential respondents are aware.
The disadvantage of this approach is that it takes longer as there’s no certainty around the type of bids that would be received. This could be minimised through early engagement with the market to determine capacity intentions before the tender is released, however this would need to be agreed with procurement and it can still be a time-consuming process.
- Only accept bids for the full 100%
If markets cannot write 100% of the cover themselves, they will need to find follow markets behind their lead bids to be able to submit a tender bid. This approach runs the risk that there will be few or even no bids if markets are not prepared to offer cover on a 100% capacity basis or fail to secure follow capacity.
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Use a broking team to negotiate the required capacity away from a formal tender
This enables the organisation to benefit from the most competitive insurance at the best possible terms, whether this is across one or more insurers. The pitfall is that this won’t be an option for everyone. Many public sector organisations are tied to formal tender processes and, even where this isn’t the case, this approach will need to be discussed with procurement to ensure it fits their requirements.
Which option, if any, works best depends on the organisation and is best determined through discussions with broking and procurement teams. For some, the formal tender process will mean alternative structures or broker-led approaches aren’t possible, while for others it could open up more appropriate and cost-effective ways of covering risk.
More information
To find out more about how alternative structures and how to access them, speak to your Aon account manager or contact Matt James at [email protected].
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