DOUBLE TRIGGER CONTRACTS

(May 2022)

Alternative Risk Transfer arrangements are typified by modifications of previous, proven methods that enhance an organization’s ability to deal with major risks. Under traditional insurance and reinsurance contracts, the insurer’s obligation to pay for a loss is initiated by a single event or trigger.

Example: Single Trigger Event
1. Insured and Insurer agree to issue an insurance policy based on parameters for eligible source of loss.	2. Within the applicable policy period, an eligible loss occurs.	3. The insurer’s obligation to investigate loss and make payment is triggered.

Single Trigger contracts, obviously, continue to work very well in most traditional coverage situations. The simple variation, of adding a second trigger creates a vastly different circumstance.

Example: Double Trigger Event
1. Insured and Insurer agree to issue an insurance policy based on parameters for eligible source of loss and upon two, independent events.	2. Within the applicable policy period, an eligible loss occurs.	3. The insurer’s obligation to investigate loss and make payment has not been triggered, so no action occurs.

Obviously, a single, unaccompanied occurrence or event has no effect on a double trigger contract.

However, an additional action does:

Example: Double Trigger Event
1. Insured and Insurer agree to issue an insurance policy based on parameters for eligible source of loss and upon two, independent events.	2. Within the applicable policy period, an eligible loss occurs.	3. The insurer’s obligation to investigate loss and make payment is NOT triggered.	4. A second event occurs within the coverage period that meets the contract parameters.	5. The insurer’s obligation to investigate loss and make payment IS triggered.

Similarity to Reinsurance

In one respect, a traditional reinsurance contract (treaty) is a rudimentary version of a double trigger contract. In order for a loss to qualify for coverage:

1. Eligible losses have to occur

2. The volume of eligible losses has to reach an amount that breaches the primary level of insurance

The resemblance to a typical double trigger agreement ends there. Under a traditional reinsurance arrangement, the triggering situations are not independent. Reinsurance merely depends upon a requisite volume of eligible loss or losses. However, a double trigger contract adds a necessary twist.

Double Trigger Twist

Unlike traditional reinsurance contracts which operate, essentially, by relying on two related events (occurrence of eligible loss(es) at a given level either via frequency or severity), a double trigger contract relies on independent events. Since the two events usually have little or no relationship with each other, they are particularly well-suited for use in covering catastrophic loss exposure.

Example: A global corporation’s revenue is generated by dozens of different business operations in different parts of the world. However, the corporation knows that it is still vulnerable if it suffers a major loss involving its manufacturing property holdings in several coastal areas or to unanticipated increases in certain metal supply costs. It arranges for catastrophic reinsurance for losses that exceed thirty million dollars, but only if, in the same policy year, its particular supply cost increases by more than 40%. In a given year, this company presumes that it is healthy enough to absorb either a catastrophic-level property loss or a huge increase in critical supply costs, but not both.

As an ART measure, use of double trigger contracts can be very complex. They are usually designed according to considerations of financial and underwriting risk and the former is not an area that is, traditionally, addressed by insurance. Double trigger agreements are often far more difficult to price since little or no actuarial or other supporting data exists.

Whether an insurer or a non-insurance entity provides multi-trigger coverage, the triggers are uncorrelated. The lack of correlation substantially reduces the probability that all of the qualifying events will take place. The lower probability increases the insurability of a given exposure and the cost is substantially less than what is available under comparable, single trigger policies. Typically, multi-trigger arrangements involve pairing an insurable event with some form of financial index rather than two or more insurable events. Under the former arrangement, there's a chance that the product will be treated as a financial derivative rather than an insurance policy (even if the contract is provided by an insurer).

When dealing with high-stakes exposures, such agreements need to revolve around two conditions that are not only independent, but they also should be highly unlikely to occur even singly during a given period of time. In other words, the conditions should be both independent and extraordinary. Triggers that do not meet both of these requirements are useless.

Example: Insurer A desires a double trigger reinsurance agreement with Reinsurer A. Insurer A’s current book of business is as follows:
Line of Business	Annual Premiums	Where Written
Commercial Automobile	$174,000,000	California
Commercial Property	$106,000,000	Midwestern U.S.
Misc. Professional Liability	$ 22,000,000	Midwest and Southeastern U.S.
Equipment Breakdown	$ 8,000,000	Continental U.S.
Insurer A buys a reinsurance contract. The first trigger requires it to be reimbursed for all vehicle liability losses that exceed forty-five million dollars in a given calendar year. There is a second trigger and the likelihood of some coverage being paid changes drastically, depending upon the trigger: Scenario 1: The second trigger is losses exceeding twenty million in losses in Commercial Property Scenario 2: The second trigger is losses exceeding twenty million in losses in Miscellaneous Professional Liability Scenario 3: The second trigger is losses exceeding twenty million in losses in Equipment Breakdown.

In light of the lines of business and the areas in which the business exists, each scenario presents a vastly different likelihood of being reached.

Trigger Independence

It is very important to take the reference to independent triggers with a level of skepticism. If you study any elements that are used as triggers, you will discover that there IS some level of dependency. Triggers represent types of losses that affect a given business; they also have a certain probability in a given operating year. It is the potentially disastrous occurrence of both (or more) of such elements that can threaten a company’s viability.

Generally, the situations that are used as triggers are a result of carefully reviewing a company’s operations and its previous loss history, particularly large losses. An effective double or multiple trigger contract is NOT one that is impossible to occur, but rather one that a level of likelihood that, while very low, still has a level of probability that will trigger protection against rare catastrophes.

The fact that there is some level of dependency means that pricing and underwriting the coverage are affected.

Note: This is a very simplified discussion of the double trigger concept. In the worlds of reinsurance and ART, this risk management method is being used in a wide variety of ways. Its effectiveness is still in dispute due to the lack of standard pricing, statistics and other measures involving its use.