Rethinking Risk Management: The Combination of Financial and Industrial Risk

Abstract

At the dawn of the new millennium, risk management is taking a different route. International corporations as well as (re-)insurance companies are increasingly turning their focus to shareholder value and the optimization of their company’s value, based primarily on return on capital and the stability and growth of future earnings. The industrial insurance market has experienced a transition from regulated national markets (product and price regulation) towards almost total deregulation. One consequence is the convergence between the insurance and banking industries often referred to as bancassurance. The result is the rapid development of new solutions for the financing of various aspects of risk. Insurance programmes have started to extend their coverage to risks that have traditionally not been insurable. Capital market products such as options, swaps and bonds, which were the domain of banks, have been adopted for the transfer of underwriting risk. Industrial insurance companies have started to place non-life underwriting risks directly into the capital market, such as earthquake and storm securitization. Across North America and increasingly in Europe and Asia, (re-)insurers are striving to extend their product range into the sphere of alternative risk transfer (ART). They are using new financial engineering techniques to release hidden values on companies’ balance sheets, aiming to serve their clients better and to afford themselves more flexibility in dealing with the marketplace of the 21 st century. The recent development and the expected increase in alternative risk financing allow large multinational corporations to choose freely from national and global markets and challenge industrial insurance companies to excel in the development of products which provide risk management solutions. Risk managers today are faced with an ever-greater range of risks, which demand new innovative solutions. International companies are exposed to various kinds of risk. Traditionally, the risk manager was responsible for looking after operating risks, whereas it was the chief financial officer (CFO)’s responsibility to deal with financial risks. Finally, it was the chief executive(CEO)’s task to handle business risk by developinga successful strategyto compete in the market. It is therefore not surprising, that although every individual developed the ‘‘right’’ strategy for one risk, the overall, company-wide risk strategy was sub-optimal. This approach often resulted in internal conflicts between the various strategies. Today, international companies are primarily concerned with protecting their bottom-line earnings and balance sheets against all non-core business risk. They are also looking for innovative ways to raise