My Heroes Have Always Been Risk Managers

When financial markets took a tailspin in 2008 Q4, the flood of bad news was fast and furious. Conditions for the collapse, however, were years in the making and their impact will likely be felt for years. What does that mean for a risk management and insurance program renewing today? A hotter, brighter spotlight — and included with that, opportunities to shine.

At the recent annual Association of Insurance and Risk Managers dinner in London, Joe Plumeri, chairman and CEO of Willis Group Holdings Limited, said: “In the current economic environment, risk managers will emerge as heroes.” Given the natural tendency to search for villains in the wake of trouble, some were surprised to hear talk of heroism. The point is that the importance of risk managers to their companies is likely to become clearer than ever. A strong risk management focus will assist senior executives in identifying risks and accessing insurance capital at an efficient cost to the business. The perception of the value insurance professionals collectively bring to the business community can be expected to grow in risk-averse times.

THE NEW QUIET REVOLUTION

The impact of the current economic recession on the Canadian insurance marketplace was first felt in the latter half of 2008. At that point, Canadian insurance companies were presented with many challenges, most outside of their control. The list of challenges remains long: limited access to credit, deteriorating investment returns, the uncertainty of reinsurance contracts, talent retention issues, increased claim costs and the influence of foreign parents over local management.

Given that the current financial crisis affects the normal course of operations for the global banking industry, it is becoming increasingly difficult for insurance companies to access the capital needed to fund operations. When investment returns deteriorated during the last half of 2008, the debt loads carried by insurance companies swelled. These factors contributed to a weakening of balance sheets for even the largest of market players, forcing some to seek relief from governments.

The global reinsurance industry has been able to maintain its capital base in the midst of this global financial crisis, but reinsurers recognize the financial market climate has changed. Many Jan. 1, 2009 renewals saw meaningful increases: primary carriers faced challenges to their capital base that led to a revived interest in reinsurance, thus reversing a decline in demand in preceding years. The fact that many Canadian insurance operations are reliant upon treaties arranged outside of Canada contributes to a lack of control and thus uncertainty.

As the economy continues to deteriorate, we will see an increase in both the frequency and severity of claims. Historically, claims increases are centered on workers’ compensation and employee benefits. The financial market turmoil and resulting recession has also inspired many executive risks claims, as investors and stakeholders turn to the courts in search of some redress for investment losses. The downturn has revealed fraudulent activities that may otherwise have gone unnoticed. The Madoff case is one very visible example.

From an operational management perspective, insurance companies, just like companies in any other industry, face increased challenges in trying to retain and reward good people while at the same time tightening expense belts. In Canada, many such management issues are driven by executive edicts at the foreign-owned parent.

Taken together, these factors have brought a measured change to many of our domestic underwriters and markets. This quiet revolution has meant a resurgence of conservative underwriting, including greater limit management and more attention to overall portfolio risk. In times of falling investment yields, carriers need to bring back profitable underwriting operations. As of now, the local marketplace is stable, with underwriters attempting to at least maintain premium levels. We would expect, however, that if the recession continues and loss ratios rise, while at the same time investment yields remain inadequate, upward pressure on rates will take hold in the third and fourth quarters of 2009. In any event, the era of automatic reductions at renewal is over.

PORTFOLIO MANAGEMENT

The need to protect existing capital at a time when access to new capital is limited will force insurance companies to pay more attention to portfolio management. Expect underwriters to examine more closely where they deploy their capacity; in some instances, they may decide to reduce their current positions through limit management.

As in any transitional market cycle, the risk manager as the primary insurance buyer will need to be more engaged in the marketing process. Buying patterns will evolve. Better information, communication and cooperation will be required of all parties involved in the insurance relationship. Risk managers must take the lead by clearly communicating the goals, objectives and expectations of their organization to both underwriting markets and intermediary partners. The key emerging themes are:

• Cost containment

• Timing

• Communication

• Differentiation

• Relationships

• Security

• Options

As budgetary pressures reduce any previous flexibility on premium costs, insurance buyers will consider higher deductibles or self-insured retentions (or both) and may re-examine limits of liability. Risk managers will look into the increasingly popular strategy of rationalizing property values — e. g., asking whether insuring to replacement costs is necessary if a property is fully depreciated and no plans exist to replace it. Risk managers are also looking more readily at benchmarking data to compare their programs to those of their peer group.

As more attention is given to the entire risk management and insurance process, seasoned risk managers will start the renewal process earlier than usual. This is a good opportunity for risk managers to review their goals and expectations with their broker partners, a smart move that is best made well in advance!

Faced with the higher expectations of their business partners, risk managers will need to improve communication by opening lines of communication internally as well as externally. Internally, risk managers would be well advised to sit down with senior executives as the buying process evolves to help ensure that corporate expectations are understood and managed. At the other end of the relationship, the risk manager should develop positive dialogue with desired markets in partnership with their broker. We would encourage risk managers to ensure that communications with underwriters are not just an annual event but conducted throughout the year.

Differentiation is another pivotal responsibility. It is incumbent upon the risk manager to properly position their organization in the most positive light and highlight the differences from their peers. A positive, clearly differentiated risk profile helps the professional insurance broker, as partner, focus on the elements that underwriters will need in order to complete their risk analysis. The more in-depth, comprehensive and attractive the profile, the more appreciative and thorough the underwriter can be, and the better the results for the buyer.

Ultimately an insurance program is the result of a partnership of professionals. The effectiveness of the partnership between the risk manager, insurance underwriters and the broker partner is critical in bringing all the components of an insurance program together. In times of market uncertainty, we rely upon the strength of our relationships to assist in smoothing the path as the market struggles to find its footing.

With the recent global financial turmoil, some of the largest insurance companies have come under scrutiny from rating agencies; financial positions are being more closely examined. The unfortunate re ality is that consideration of the market security of your counterparties is now a mandatory element of any renewal process.

If this transitional market is the precursor to a hard market cycle, the risk manager will likely consider captives and other alternative risk transfer mechanisms. Although insurance transfer to traditional markets was economically advantageous in recent years, other options will appear more attractive as a more adverse market takes shape. The goal of the risk manager is to retain ownership and control of the mechanisms for risk transfer or finance and not become a victim of rapidly changing market forces.

Adversity and change offer opportunity. Risk managers today are a critical part of the management teams of their organizations, as the executive suite looks to strengthen the risk management function, remove vulnerability and eliminate potential surprises. Do not underestimate the role of the risk manager in providing much-needed guidance through these changing times.

Turning again to the words of Joe Plumeri,”…we need to see the opportunities in the adversity and make a parade out of a financial riot…”We believe that risk managers should be among those leading the parade..