The “holistic” approach to risk management is gaining a following. As companies discover the benefits of arranging single policies to mitigate a variety of risks, AIG Risk Finance has been at the forefront of innovation

Insurance oracle Maurice Greenberg, chairman of global heavyweight American International Group, surveyed his company’s varied divisions and areas of expertise in 1995. He decided to bring together a small group that could provide clients with risk solutions that span both the insurance and derivatives markets. New York-based AIG Risk Finance was the result. The firm is now at the cutting edge of enterprise-wide risk management, aggressively innovating comprehensive policies that can cover packages of diverse insurance, financial and commodity risks.

The emergence of multi-risk insurance policies – which can include a range of traditional property and casualty insurance along with interest rate, currency and commodity risk cover – has paralleled, and in some cases led, the trend among companies to centralise their risk management. “Organisations are continuing to embrace this concept,” says David Fields, senior vice-president of risk finance at AIG. “It is manifested in the growing numbers of chief risk officers,” he says. This contrasts with the traditional model where different corporate risks are managed in “silos” – commodity risks by purchasing teams, financial risks by treasury and workers’ compensation insurance by human resources, for example.

Another element spurring this trend is the derivative market’s enduring bad reputation among corporations. “Some companies feel safer in insurance,” says Tobey Russ, president of AIG Risk Finance. From the client’s point of view, these policies look like insurance, despite often having derivatives under the hood.

The AIG product, called Commodity-Embedded Insurance (COIN), is one of several offered by AIG Risk Finance. It falls under the rubric of the alternative risk transfer products group, which also offers products to hedge risks such as weather and environmental (for example, nuclear plant decommissioning), along with products that assist insurance companies to demutualise.

The other, structured financial products, group offers credit-related products such as asset-backed wraps and financial counterparty intermediation. AIG can leverage these products and skills to expand its COIN offerings as companies develop their appetite for managing risks in a holistic way, Russ says.

Several companies have entered this business in the past two years. Swiss Re and Reliance National, in particular, have made very strong showings. Reliance National developed a product called Enterprise Earnings Protection Insurance, which insures the operating streams of companies. It focuses on an overall earnings shortfall against a basket of risks, rather than on single risks. Swiss Re is also growing its business rapidly, reinforcing its reputation as a leading risk management innovator.

However, AIG has established itself as a trailblazer. The firm arranged in 1998 what is widely believed to be the first policy to integrate traditional insurance and financial risks for Honeywell, the Minneapolis-based manufacturer of aerospace, industrial and heating systems. The deal covered worker’s compensation, transit, property, political risk, product and general liability, along with currency translation risk. Honeywell estimated that it paid 20% less in premiums compared with its previous, non-integrated policies.

The savings come from the lack of correlation among the various risks in these contracts, along with potential tax and accounting arbitrage opportunities, Russ notes. Indeed, the firm usually holds most of the exposure in these transactions rather than selling or hedging it away – other than any catastrophic risk elements – to maintain the benefit it receives from the non-correlated nature of the risks.

AIG can occasionally provide savings of 20% to 25%, but premium benefits are more typically 10–20%, Fields says. The magnitude of the savings depends on the relative sizes of the exposures. Savings are greatest when the sizes of the various exposures are relatively similar, as that makes for the largest savings from non-correlation. Fields says if two non-correlated risks of roughly similar size cost $3 million and $4 million to insure separately, together they might cost about $5 million.

The AIG product can be structured to include all the traditional insurance coverages such as property and casualty risks, political and environmental exposures. Among the financial and commodity risks AIG has included are currency risks, interest rate risks, weather risks (such as heating degree day-based transactions) and commodity price risks. AIG has worked with some commodities that are either illiquid or otherwise difficult to find, Fields says, such as pulp and paper.

Although AIG declines to discuss specific transactions, the firm was widely believed to have structured a groundbreaking transaction for Mead Corp, the Ohio-based paper products company. The deal provided coverages for traditional property/casualty needs, foreign exchange risk and commodity prices including inputs to the paper and cardboard manufacturing process.

AIG’s 75-strong group consists of 20 financial engineers and others with backgrounds and expertise in investment banking, insurance, asset management, derivatives trading, tax, accounting and quantitative analysis, Russ says.

The firm declines to break down its business by deal type, but Fields says AIG Risk Finance expects to complete 175 transactions this year, up from 120 in 1998. The growing sophistication of corporate risk managers is a significant driver in the expansion of this business. “This is clearly changing,” Fields says. “The reactions are a lot different than in the conversations with clients two years ago. People are now ready to embrace this,” he says.

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