Using Private Equity Models to better understand insurable risks

27 March 2017

There are various contemporary pressures on insurance: commoditisation, convergence of insurance and capital markets, regulatory and compliance to name a few.

But an enduring challenge for in-house risk teams, brokers and (re)insurers has been articulating the value of insurance to senior management.

We think of value in terms of client’s business – the capital structures of our clients’ businesses – the value that Boards, investors, and top-Execs actually care about – not some kind of hypothetical ‘total insured value’.

Insurance can also be shown in terms of its protection of clients’ returns. The private equity sector uses ‘J-curves’ to do this, and we think that it’s reasonable to do the same to articulate the positive impact of appropriate insurance.

The following diagram shows a client’s capital structure, its enterprise value (EV); and the value of the business in the longer-term. Also, the profile of the client’s returns—the internal rate of return (IRR).

Then we see a risk-affected scenario (below). Here we source data and evidence of risk from the insurance market and we incorporate this into scenario-modelling.

Risk is uncertainty affecting future cash flows. So we think that taking risk down to first-principles (down to the cash flows) makes sense, thus handling the difficulty of articulating the value of insurance, right?

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