Aon and Willis provide syndicated insurance – at last!

Last week Willis announced their initiative to provide syndicated insurance, referred to by the FT as ‘passive’ underwriting. Earlier this year Aon announced the same syndicated insurance methodology. I have seen criticism of this scheme but structured project finance specialists such as myself have been screaming for this methodology since the mid 1990’s.

The reports that I have read attempting to describe this offering do not fully appreciate why this is so necessary in the corporate sector, so a little background might be useful. Banks are in the business of asset risk, whereas insurance companies are in the business of event risk. When a prospective borrower presents a project to a bank, that bank will take the responsibility to evaluate the project and the financing requirement, including the associated inherent direct and indirect risks. The bank will then decide whether or not to fund the project. Little does the borrower know that the bank is likely to syndicate this funding with a number of other banks each taking a percentage of the financing based on the good judgement of the borrower’s bank. If funded through a private placement then this syndication will be invisible to the borrower.

The bank is likely to identify certain event risks, e.g. business disruption, for which it will need insurance cover. Using traditional methodology the borrower will then have an insurance broker approach the insurance underwriters to arrange cover for the various event risks identified. What comes back is a number of policies using different wording platforms, and even different legal jurisdictions. This does not instil confidence into the bank’s risk profile, and why banks generally do not give credence to what these various policies purport to provide. In the event of a potential claim which underwriter does the bank approach?

I would like to introduce 2 extracts from a MBA text book on structured project finance that I co-authored in 1999. Both are from one of the chapters called ‘The Role of Insurance in Project Finance’.

“Our own experience suggests that both insurers and bankers generally state that they are flexible and adaptable, but in practise usually confine themselves to tried and tested solutions. For example it took two years of negotiation, cajoling, and debate convincing insurers that the structure of our “One-Stop” Construction Risks product was a radical and valuable improvement in the provision of a reliable solution for the support of major construction project financing. If I had to identify the major factor in the reluctance to adapt to the inherent changing role of the insurer with such a product it was the degree of change in approach of providing a packaged integrated risk mitigation solution which is flexible, but contained to one major lead underwriter on one legal platform. In essence we did no more than to use tested principles of bank syndication and adapted it to the insurance market. The initial reaction of the bankers was “too good to be true”. The lawyers view was that it would remove at least 80% of construction litigation as many of the difficulties inherent in construction litigation and particularly as to the apportionment and extent of liability could be avoided, but they were not sure that bankers, or even developers, are ready for such a radical shift in thinking.

On the other hand we have produced an integrated insurance solution [with Aon] for a wide range of project risk mitigation including investor risk, cash flow risk, business disruption, all within a political risk envelope, for a Euro-convertible bond offering for a complex project in Eastern Europe which was only acknowledged by the bankers for what the insurance brought to the deal when the issue was very well received and became oversubscribed, whereas prior to the integrated insurance component there was no interest. In this offering the insurance component was an integral part of the Trust Indenture Agreement [a ‘first’ in an international securities offering] which made for a robust structure to which investors could relate and feel secure.

Our resultant observation is that both parties need to be brought together in a spirit of mutual understanding and co-operation if the bankers are to enjoy the value and benefits available through effective risk mitigation insurance tools, and insurers need to adapt to a more flexible approach to ever changing risk profiles. Furthermore there is a language barrier between these two sectors that needs to be overcome by both parties as misunderstanding plays a large part in the lack of integrated solutions.”

Aon and myself wrote the policy wording that we needed, and Hiscox took the lead underwriter role of the event risk requirements for the eurosecurities issue even though there were aspects of this package that they, themselves did not underwrite. They acted as a lead underwriter and placed all the risk within their underwriter community – invisible to us, just like a bank syndication – and only one underwriter for the bank to engage with.

“Project Finance Requiring Political Insurance

This is a very specialised area of insurance as, by definition, the project is in a territory that has less certainty of political stability and/or appropriate legal structure than one would like in order to secure an investment or lending position in the event of problems. Such political insurance is available to cover a whole host of possibilities such as:

• Confiscation, Expropriation, and Nationalisation
• Forced Abandonment
• Transfer Risk
• Refusal of host Government of Repossession and Disposal Rights
• Contract Repudiation
• War, civil war, civil unrest,  and terrorism

However there can be a number of interested parties that need cover within any one project, and there can be a number of different scenarios that require the security of a political insurance wrap in order that they are effective. This is further complicated by the fact that it is not always possible for any one insurer to assume the total insurance package thus various legal platforms for each insurable risk need to be interpreted and reconciled. It is our firm belief that the current practise with insurers will radically change over time such that one major insurer will assume a lead manager role, much along the lines of a bank lead manager, providing a single source of full insurance cover on one platform.”

It has taken some 13 years for this concept to mature, and I applaud Aon and Willis for their belief and understanding of the need for this approach. I hope that the banks welcome this approach with open arms.