A Derivative Path to Insurance

Toronto Insurance Conference (TIC) president-elect Robert G. Harrison took a derivative route into the commercial insurance industry – literally.

Once a trader in financial options and futures for CIBC Wood Gundy in the early 1980s, Harrison worked in Bermuda for 10 years at The Bank of N.T. Butterfield & Son Limited, Bermuda’s first and largest independent bank and a specialist provider of international financial services. After returning to Canada with his family in 1999, the Charter Financial Analyst (CFA) landed at Martin Merry & Reid Limited in Toronto, where he is currently an account executive. Harrison describes the transition from the financial services world of trading in futures, options and derivatives to the property and casualty industry as “very straightforward.”

“The thing about derivatives in the financial business is that it’s all about risk management,” he says. “The basic concept of a derivative is a risk transfer vehicle. So you have someone with an exposure – take a mortgage lender, they have exposures such as changes in interest rates – and derivatives are to ameliorate that kind of thing.”

Stated simply, derivatives are contracts between parties that specify conditions under which payments or payoffs are to be made between parties. Harrison said risk management in the financial world is all about knowing how the various contracts work. This entails a legal understanding, and also basic mechanical understanding of what the derivatives contracts can do and what they can’t.

“Like any risk problem, you break the risk down into its constituent parts and then you apply what you can in terms of contracts with third parties to mitigate – to transfer that risk to a place,” he said. “So the transition from the financial management to the insurance management [of risk] was one of nomenclature more than it was one of attitude and background and objectives. So really, the transition was not that difficult.”

If there is a difference, it may be that the risks in the financial world of derivatives are quantifiable (arbitraging between two different currencies or interest rates, for example), whereas the risks in the world of property and casualty insurance are fortuitous and therefore less predictable.

“As I like to tell people, in the financial marketplace, I can take two interest rates and two currencies and arbitrage them with certainty,” says Harrison. “I know exactly what I’m taking out of the middle, what my exposures are and what the payouts are.

“In insurance, while I can break down the risk, insurance is based on a fortuitous event. It’s something foreseeable, but not predictable. So it translates, but not perfectly. Today, at the end of the day, the only arbitrage one can do on the price of insurance is look for somebody else’s price. And at the end of the day, you are a price-taker – as a client and as a broker, for that matter – rather than as a price-giver.”

Harrison’s experience in commercial insurance began in 2003, when David A. Browne, a principal at Martin Merry & Reid Ltd., recruited him into the commercial insurance brokerage’s Toronto office. Among Harrison’s specialties is D&O and E&O insurance for financial executives. “Trading in the Canadian futures market, it’s a thin marketplace with a limited number of providers,” he says. “[The business involves] negotiation skills and, at the right time, brinkmanship. So when it comes to a client – I have an affinity for financial clients, be they fund managers, hedge fund managers or brokers – I can translate their insurance risks into what their [insurance] underwriter needs and vice versa.”

In the same way the Denver Broncos professional football team has a knack for recruiting elite running backs, Martin Merry & Reid seems to have a history of churning out TIC executive members. Browne was a past board member of the TIC and most recently Justin MacGregor was president of the TIC in 2005. “So when Justin was leaving the TIC, they were looking for another member,” Harrison said. “I thought it would be a great way to get some contacts and learn a bit more, so I joined the TIC in ’06 or ’07.” All things going according to plan, Harrison will formally take over as president of the TIC at the organization’s annual general meeting in March 2012.

Harrison said most of the issues he expects the TIC to face next year are already “out on the table.”

Once employed by a bank, Harrison certainly has an acute sensitivity when it comes to banks entering the world of commercial insurance. “I believe they are beginning to move into that area,” he says. “We know that Royal Bank is talking about commercial insurance and TD Bank is moving slowly into small commercial side of things. That will continue to be something that we need to monitor.”

To date, Harrison adds, banks have been “more contemplative” than active when it comes to entering the commercial insurance arena. This caution may stem from getting a handle on how best to enter the commercial marketplace. “It’s a different arena,” Harrison said of the difference between commercial and personal lines, where banks have more of a presence. “Personal is regulated. It’s pretty straightforward. You find a price point, do some research in the programs, look for your losses, define where you want to be, the programs you want to look at, who you want to do it with.” Pricing in commercial lines, in contrast, is not as straightforward, and thus banks are taking their time doing their research before dipping their toes into the waters.

When they do, the key is to make sure a level playing field exists between banks and commercial insurance brokerages, Harrison said. “We are happy to have competition. Competition is good for everybody. But the issue of a level playing field, [highlighted by] the announcement of the ministry in terms of the Internet banking and insurance issues, that will obviously be an ongoing concern.”

Another area of interest for the TIC is solidifying the entrenchment of a public emergency endorsement in commercial insurance contracts. The TIC successfully worked with the Insurance Bureau of Canada (IBC) to create a public emergency endorsement intended to protect consumers when their policies are about to lapse during a public crisis. IBC’s board approved the resultant document in September 2009. Among other things, the endorsement extends the term of an expiring policy or suspends the notice period for a pending cancellation after the declaration of an emergency.

The TIC is now acting to make sure that the endorsement is adopted in insurance contracts as a matter of course, and not in a piecemeal basis.

“Buy-in from the executives of all of the insurers seems to be done, but it’s executing now and making [the endorsement] occur or appear in all of the contracts without having to remember to reflect and endorse in every policy,” Harrison said. “There’s work to be done to make that a fait accompli, as opposed to everybody agreeing it’s necessary but not everybody is adding it in there.”

Education is a third priority for Harrison. He noted TIC accomplishments in this area, such as a financial sponsorship with Fanshawe College in London, Ontario. “We provide funding for a student in their insurance program who has expressed a real interest in commercial insurance,” he said. “That dovetails with the new MBA in insurance, and also the IBAC Elite Broker program.