Managing Global Risks: Running for Cover

“The Canadian and global economy is changing at such a fluid and dynamic pace that ‘globalization’ is occurring at a pace that five years ago was unknown,” observes Clint Lutkins, president of Zurich Canada’s corporate customer division. “With worldwide consolidation of industries through mergers, acquisitions and the like, we’re seeing on the one hand a shrinkage of Canadian corporate clients while the surviving enterprises are becoming vastly more global in scope,” Lutkins add.

This “globalization trend” has introduced a host of heretofore unrealized risks – political risk, kidnap and ransom, financial perils such as credit and currency exchange risk, new areas of liability and of course, exposure to international catastrophe losses. While the scope of international losses may not be greater than those faced domestically, Lutkins notes, the standards for risk control can vary greatly, leaving companies open to more severe losses. “Standards of loss prevention are much better ingrained here than in some other parts of the world.”

And with the need to insure for these losses, risk managers are faced with dealing in the legal environment of foreign countries, including different insurance regulations. The idea of going to your insurer and asking to be covered for these international risks in the same way your company’s domestic risks are covered is not so simple in reality. Zurich is among very few companies who can offer coverage for a range of international risks, and the number could be shrinking. Given the industry’s poor results – both in the primary and reinsurance markets – insurers are more likely to be pulling out of markets, rather than entering into new ones. Thus, risk managers face an uphill battle in understanding and finding coverage for this “brave new world” of risk.

Big gap

Part of the issue may be a lack of understanding of these perils among risk managers. For a company setting up bricks and mortar operations in another country, the risks are perhaps more obvious than for the many companies, large and small, who export out of Canada.

But exporting brings a host of its own risks, and with the development of Canadian exports comes a growing need for coverage of political and financial risks. Canadian exports, which just ten years ago accounted for 33-34% of gross domestic product (GDP), now account for about 45%, notes Keith Milloy, vice president and chief underwriter for the Export Development Corporation (EDC). He notes that, while the EDC has certainly seen growth in its credit and political risk insurance business, there is a great deal of ignorance about the need for coverage.

Penetration of the credit insurance market in Canada is about 10%, whereas in Europe the figure is more like 25-30%, he says. “We’re doing a lot more business than we were 10 years ago, but there’s still a big gap.”

It is often the case where a company does not realize it needs coverage until it is asked for a certificate of insurance, notes Wanda Thrush, vice president of insurance wholesaler, Cross Border Underwriting Services (CBUS). She says brokers have been pushing CBUS to educate and inform them and their corporate clients about the risks involved in international trade.

Lutkins observes that some of the more established companies have a good handle on their global exposures, but for start-up companies there is a great need for education, particularly with the growth of the information technology (IT) sector. For start-ups or companies moving into a new market, “insurance is usually among the last things they deal with”, notes Doug Smith, west-coast regional manager for North America for World Source, an AIG company devoted to international risks. He adds that smaller companies with no dedicated risk management staff may be at a disadvantage.

Milloy explains that it is in a company’s best interests to fully explore international coverage options. In the case of credit insurance, with accounts receivable being generally the second-most liquid asset on a company’s balance sheet, he says, and it makes no sense not to protect those accounts. Having credit insurance rather than asking buyers for a letter of credit or cash up front is part of remaining competitive in the marketplace. And, he adds, banks are more willing to discount accounts receivable for companies who can demonstrate that they have coverage in place, than for those who do not. In the end, insurance can represent “a big, big working capital boost”.

For companies dealing in a variety of foreign markets it is not realistic perhaps to expect risk managers to have expert knowledge of the perils in each of these markets. Moreover, understanding the different insurance options and requirements and other laws is in itself a full-time job, insurers agree. “Major exposures such as earthquake/weather are obvious [to risk managers]. What is less familiar is when admitted versus non-admitted paper is required, what the pollution laws are in various regions and the legal system and environment,” notes Sandra Osata, manager of risk management for Royal & SunAlliance Canada.

U.S. liabilities

Risk managers may be well aware of the exposures they face, but given that those exposures can change almost daily, quite literally as fast as the weather changes, staying ahead of the game is difficult. This is no more so true than in the U.S., where the EDC estimates 88% of Canada’s exports currently go. “The rate of change in the U.S. is accelerating,” says David Eastaugh, president of Elliott Special Risks.

Changes in the legal environment in particular are creating an “inflated” level of inflation there, he says, somewhere in the range of 12-15%, versus the normal 3-4%. Companies relying on coverage bought several years ago could find themselves behind the eight ball in this environment. The U.S. is “the most hostile legal environment” in the world, Eastaugh says. Companies dealing there want to “load up” on excess liability coverage, knowing that, should they end up on the wrong end of a lawsuit, the cost could be astronomical. A case that in Canada would result in a $25,000 award, could be more like $25 million in the U.S., Eastaugh notes. “The U.S. is such an attractive market, you just can’t avoid it. But is does come with tremendous pitfalls.”

Thrush says product liability has become the single biggest concern for companies dealing in the U.S. market because of the litigious environment. Lutkins also notes that executive protection from lawsuits has grown as a result of the rise in litigation. “The cost of managing that kind of risk has skyrocketed.”

Milloy suggests that the current woes of the U.S. economy, which has moved into a “recession alert”, are also affecting Canadian companies exporting there. Bankruptcies in the U.S. retail sector, as well as other key markets such as steel, have Canadian exporters seeking coverage for buyer default. 2001 shows no signs of improvement. In fact, it is predicted that the record number of U.S. bankruptcies last year will be “shattered” in 2001. Already 127 U.S. public companies have gone belly up.

Another issue is whether companies fully appreciate the risks involved in their U.S. dealings on the same level they do other international exposures. Milloy fears they do not. “My own guess is that they don’t view the U.S. as an “export” country, they view it as an extension of their domestic operations. As such they don’t perceive the risks involved.”

Expanding markets

Despite the preponderance of trade with the U.S., Canadian companies are now dealing in foreign markets as never before, and facing the risks those countries bring. Beyond the U.S. no other country or specific risk stands out as the “key risk”, insurers note. And this depth and breadth of perils is what makes international operations so taxing for risk managers.

“80% of Canadian exports go to the U.S., so there’s 20% that’s going other places. Plus there’s the capital that’s being placed in building operations around the world. So there’s a lot of money that leaves Canada, that’s supporting Canadian business, beyond the U.S. ,” explains Jan Tomlinson, president of Chubb Canada. She sees companies expanding into new markets, including Europe, Latin America, the Far East, Mexico and more recently, China (which has become of interest lately because of its decision to begin licensing insurance companies).

“Given the nature of the Canadian economy, most exposures are in the U.S.,” Lutkins says, but his corporate clients, including the likes of Nortel and Alcan, sometimes deal in 10 or more countries. Similarly, Smith notes that World Source clients, many of whom are involved in the energy sector, are looking at a variety of risky countries from the Caribbean to Kazakhstan.

Smith also notes that the host of risks companies face is widespread. The U.S. is not alone in its increasingly litigious environment, he observes. “It is fair to say that in Europe there is a growing awareness of legal rights as respect product liability.” But for energy companies, who deal in “tough” countries, political risks, kidnap and ransom and terrorism are common concerns.

Osata notes that companies are dealing with a vast array of perils, depending on whether they are setting up bricks and mortar operations abroad or simply exporting there. But many of the same risks that affect domestic operations are also of concern, such as theft.

For companies involved in export, global financial crises are of great concern. Beyond fears of a U.S. recession, economic slowdowns or outright failures in countries like Argentina, Japan, Turkey, Brazil, Ecuador, have sellers worried. “The spillover effect from difficulties in these developing economies can be rather profound for Canadian exporters,” Milloy says.

All in one

With such a vast array of risks in any number of countries, Canada’s corporations may be looking for an “all-in-one” insurance buying option. In fact, whether or not to have one insurer handle all of a company’s international exposures is a key question, says Lutkins.

In this respect, Lutkins sees a progression towards “program insurance”, such as global master controlled programs. “Among Canadian corporate clients who are growing internationally, and particularly growing through acquisition, there’s very often a philosophical approach that you could call decentralized. They don’t want to offend the local personnel of newly acquired entities that might have had long established relationships with local carriers.” These companies would look to domestic insurance companies for “umbrella” or excess coverage, in the form of DIL/DIC (difference in limits/difference in conditions) coverage, which is beyond the coverage they purchase in foreign markets.

But, as companies become more familiar with the international environment, bundling coverage under one insurer tends to become the preference. Clients who prefer to more aggressively manage risk, tend to go with local coverage provided through a domestic company through a global master controlled program, Lutkins says. Many foreign countries demand local admitted coverage (coverage from a licensed insurer in the foreign country, rather than a Canadian insurer) for some risks, so often companies will end up with a combination of local and Canadian coverages.

Most companies want an insurer who can manage their whole program, agrees Smith. “Smaller companies find this out later,” as they become more involved in international trade. Often, he adds, certain lines of risk are excluded from the global master controlled program, such as auto insurance, which can be bought locally.

Tomlinson says “comfort level” is one reason many corporate clients want to stick to a domestically run program, to deal with insurers and brokers with whom they are already familiar. In the event of a loss, they want to have to deal with one insurer who they know well. Osata notes that “it is not realistic to expect that every insurer can be the best at everything”. However, she says, global master controlled programs are preferable. It is up to insurers to ensure that each customer and each country is treated in a customized way.

Finding cover

But how easy is it to find all-in-one coverage? Not so easy, insurers agree. Only a handful of companies have the resources and global networks required to insure clients through local admitted policies as well as domestic umbrella coverage.

“There are tremendous entry barriers” to companies offering this type of coverage, admits Lutkins. The cost and time involved in building up a network of local insurers is one issue, as is a “corporate culture” Lutkins sees as resistant to integrating insurers’ international operations to service clients in a bundled program. Cost is also an issue here, he adds, particularly the high cost of integrating technology systems to provide clients with seamless service from a number of countries, which could run in the tens of millions of dollars. “Very few companies have been able to pull that together.”

Others agree that cost and time are the key barriers to providing a comprehensive international risk program. “For a company [insurer] to start doing it now would be difficult…it’s a very expensive proposition,” says Smith.

Some in the industry are also seeing difficulty in getting expanded coverage given the poor state of the insurance industry worldwide. Companies are dropping lines of business, not adding them. “Even for a Canadian company seeking expanding coverage, we’ve seen companies shying away from that. I’m not seeing an overeager or overaggressive market,” says Heather Masterson, director of corporate marketing for AIG in Canada.

Thrush notes that even in the U.S. environment brokers are having difficulty with shortage of cover. While exports are expanding, the number of insurers and intermediaries dealing in this coverage is not. Obtaining local admitted coverage can be an even greater ordeal. Finding reliable, well-capitalized foreign carriers is not easy, observes Eastaugh.

Osata notes that while coverage can be found, finding specific coverage in a specific country can be difficult. “For example, it is more difficult to obtain a kidnap and ransom policy in Columbia than it is in France, or earthquake capacity is more difficult in Japan than the U.K. Capacity is available, but it is much more restricted in highly exposed areas, and the costs are significantly higher.”

Hard times

Cost is becoming a key point in any discussion of insurance, given global hardening of insurance rates and tightening of terms. “The hard market is a worldwide issue, and is actually harder in some countries outside of North America,” notes Osata. “Canada is catching up quickly but the pace has been much faster in the U.K., for example.”

Lutkins agrees that “everyone is keenly aware of global hardening”, and particularly in the U.S. which has been the most aggressive about rate correction. The London market, in which a fair amount of Canadian insurance is handled, has also tightened considerably, he adds. “It becomes a global phenomenon, in that we’re dealing with a small number of global reinsurers who’ve faced pretty poor results over a period of years, as has the primary insurance industry.”

Lutkins says corporate clients are looking for “long term relationships” with insurers as a means of riding out sharp spikes in rates. “There’s no hiding place in the world because over the last five to six years the reserve margins of most of the industry have come down, the accident year loss ratios are deteriorating, and there is a need for some price correction. I imagine we’ll see an 18/24-month hardening cycle,” he predicts.

Eastaugh notes that the U.S. market has already been firming for about 18 months now. “The rate correction in Canada will be just as vigorous as the rate correction in the U.S.,” he predicts. He does, however, admit that the pricing correction underway is a much needed recovery tonic after the unsustainable low rates of the 1990s. “The bean counters are finally in control, and that’s a good thing.”

But for corporate clients living through economic slowdown in Canada, the news of an upturn in the insurance price cycle is less than welcome. “No one likes it especially because their businesses aren’t growing financially the way they were two years ago,” Eastaugh points out.

Will this hardening signal a turn to alternative risk transfer (ART) in the global risk market? Insurers are divided. But, as Osata notes, it appears ART is becoming a more popular option for domestic risks, so there is no reason to think that the international risk market will be any different.