In a Complex and Riskier World, It’s Time to Rethink Access to Capital
February 2, 2022
Whether it’s to help businesses meet strategic goals or address the risks that seem to grow ever more complex, capital is the lifeblood of any business. The right type and level of funding can also help address perils that might threaten growth, such as natural catastrophes and the impact of climate change or human-made threats such as cyber risks.
Businesses are increasingly looking beyond traditional sources of capital when addressing today’s challenges. Some might be considering new ways to meet the cost of covering emerging and growing risks or to address pension obligations. Others might be trying to find ways to connect with new and different types of investors.
In many cases, these efforts are aided by innovation in deal structures and powered by data and analytics. The goal is increasing the pool of capital available to meet an increasing number of business needs and risks.
“We need to work with our insurer partners and other capital sources to create risk transfer solutions,” says Anne Corona, CEO Asia Pacific at Aon. “Not just for a more holistic cyber solution, but to also make a market around valuing and protecting intangible assets and intellectual property and helping with the energy transition.”
Risks such as cyber threats and climate change are often interconnected with other exposures facing businesses and societies. These potential exposures are vast, and to address them and their volatility effectively means tapping new sources of capital.
Bringing in new investors – and creating new markets — can also play a significant part in encouraging businesses to take on the risks associated with addressing climate change, such as a higher frequency of supply-chain disruption due to the impacts of severe weather.
Data and analytics can enable tools like parametric triggers on investment instruments, which can provide the incentives needed to encourage capital markets investors, pension funds and others to contribute to the pool of capital available to address some of these exposures.
“If we can collect like sets of data, we can create insights and analytics around those insights that can create value for investors,” says Andy Marcell, CEO of Reinsurance Solutions at Aon. “If we can properly parametrize something like catastrophe risk — and we can — you can actually serve the less-advantaged communities of the world.”
New Capacity for Catastrophe Risks
Marcell notes that firms looking to protect against increasingly severe natural catastrophe risks are seeking new sources of capital as some traditional investors grow wary of the increased volatility. Better information can help secure the new capital needed to address some of those risks.
“As capital leaves, we need to find ways to bring in new capital to meet that risk,” Marcell says. “And, simply put, the only way to do that is to be able to quantify or parametrize the upside and the downside of those risk events.
“This provides a framework so that commercial risk brokers have a better understanding of the risks that they’re assuming. As a result, they can make better informed decisions about what they’re willing to invest in terms of protecting them.”
“They are transferring risk in a more volatile world for the benefit of everyone,” adds Marcell. “And the investors that take that risk also make a return because they understand, through tools and insights, how to do that effectively.”
Engaging Capital Markets
Catastrophe bonds and other insurance-linked securities (ILS) are examples of capital markets being willing — even eager — to provide additional capital to address risks. Catastrophe bond and ILS issuance hit new records in 2020, as investors saw them as a diversifying asset in their portfolios.
“2020 was an absolutely tremendous year for the usage of catastrophe bonds,” Marcell observes. “Investor appetite has been stronger than traditional reinsurers’ appetite for what we call traditional reinsurance.”
Non-insurance entities such as New York’s Metropolitan Transportation Authority and Google have looked to the catastrophe bond market to address risks as well.
“There is significant appetite from the capital markets that provides securitized insurance risk in the form of a catastrophe bond or other bonds to large corporations,” says Marcell. “I think it’s important that we all recognize that the market is there, that the need will be there and the demand will grow. And that we have to organize ourselves over the next 12 months to make it more standard practice.”
Addressing Pension Plans’ Capital Impact
For many companies, pension plans present another opportunity to rethink their capital structure.
“If you listen to the earnings calls of most major firms, at some point, the CFO is going to talk about the cash needs of the pension plan,” says Paul Rangecroft, CEO of Wealth Solutions at Aon. “For many companies, their pension liability is significant versus the market cap of the company. So, this is a colossal issue.”
Capital deployment into pension plans becomes an access to capital issue, Rangecroft explains, with the plans essentially acting as variable debt as interest rates or stock markets move and gaps between plan assets and liabilities grow or shrink.
“So, in terms of managing capital, you’ve got to think about where you’re best suited to deploy cash into pensions, versus keeping cash in the business,” Rangecroft says. “And where do you have flexibility between the two?”
For multinational companies with pension plans in numerous countries, local regulations will determine where the business might have that flexibility. According to Rangecroft, deciding how to deploy capital into the funds in these countries should be done on a global basis rather than locally. Such an approach can help the business get the best return on that capital.
“If you have a really desperate need for capital within the company, understanding the pension requirements everywhere locally would be a very material and interesting way to think about how to build up flexibility that can enable you to retain cash in the business during times of stress in the system,” Rangecroft says.
Embracing New Approaches to Capital
In part, the challenge to rethinking access to capital is thinking creatively about new opportunities and overcoming traditional ways of working. How do we make markets that are necessary but don’t exist?
“It’s important because the world has become more complex,” says Marcell. “The appetite for alternative markets has expanded. We need to bridge the gap with communication and planning.”