Risk Management: It’s a Buyer’s Market

Despite deteriorating conditions in the property and casualty insurance market, insurers continue to slash already low premium rates. Market observers forecast this trend to continue for at least 24 months as insurers prioritize marketshare over revenue prosperity. Simply put, the insurance price war – particularly intense in the commercial lines arena – can only lead to a sustained buyer’s market. Against this insurance backdrop, risk managers as a profession have broadened their skills and duties beyond the traditional cover purchasing function. With new risks and approaches in risk rating emerging in the market, the risk manager is coming of age at the corporate level.

The newly released 1998 Risk and Insurance Management Society, Inc. (RIMS) Benchmark Survey, conducted by RIMS and Ernst & Young LLP, illustrates dramatic change awaiting the risk management profession.

Polling 865 American and 86 Canadian risk managers, the survey concludes the cost of insured risk continues to decline, the insurance market remains competitive, interest in new risk-financing vehicles is increasing and risk managers are expanding their corporate roles. These results are consistent with CU’s survey of Canadian risk managers, who are increasing their corporate profile while keeping one eye firmly fixed on insurance industry developments.

Susan Meltzer, assistant vice president of insurance and risk management at Sun Life Assurance Company of Canada and the incoming president of RIMS, says risk managers should not be concerned with the short to medium-term insurance rate outlook. “I just don’t think you’ll see a market correction. There’s too much capacity heating competition in the market. Besides, who cares? The last one [correction] only lasted a year and rates have been declining ever since.”

RIMS statistics support Meltzer’s analysis. The Canadian cost of insured risk, according to the Benchmark Survey, reached a ceiling of $3.90 per $1000 of revenue in 1990. Since then, the figure has slowly declined hitting a decade low of $2.13 per $1000 in revenue in 1997.

U.S. insured costs were on the rise until 1992, hitting a decade high of US$8.30 per $1000 of revenue to steadily fall back to 1997’s level of $5.25 per $1000. While these figures indicate that insured risk costs are in steady decline, the U.S. rate is shown to track the combined ratio of commercial insurers — which also hit a decade low in 1997 at 87.9%.

Don Smith, president of TRAC Insurance Services, notes combined ratios have been declining but forecasts the ratios will rebound. “There’s no question underwriting ratios are strong now but the general feeling is that combined ratios are not going to keep declining, they will soon flatten out or rise. With continued low interest rates — and the majority of insurer investments in bonds — investment income will worsen as well,” he says.

Bending over backwards

All of which would indicate commercial rates will spike upward. Still, Smith says the competitive environment that is sparking consolidation will continue to restrain commercial rates. “Companies are working for marketshare and not for underwriting profit. My gut instinct is that risk managers can count on this for a while, and won’t have to worry about huge increases for at least 24 months.”

As further testament to the eager response of insurers and service providers to the commercial buyer’s market, brokerage J&H Marsh & McLennan recently announced an agreement with RIMS to establish a procedure for disclosure of contingency earnings. A long-standing contentious issue with the risk management profession, J&H Marsh & McLennan’s move opens a door on broker commission disclosure which many risk managers believe will lead to the opening of a floodgate. In this vein, competitor broker Willis Corroon issued notice that it plans to offer corporate clients the option of excluding their premiums from contingency fee negotiations.

Keeping watch

Even with these considerations, and the two-year declining rate forecast, some risk managers are skeptical about the insurance market, and are investigating other risk vehicles as contingency options.

Brad Silver, risk manager at NOVA Chemicals Corporation, is weary of this so-called “buyer’s market”. “My concern with this soft market is when you go through this cycle, there’s bound to be a rebound. And no one knows when it will occur,” he says.

Silver has been examining alternative risk transfer and capital market solutions as contingencies in the event of a significant rate hike being applied. He readily admits, however, that the current moderate cost of premiums renders alternative planning to theory, “we’re monitoring the alternatives but obviously the economics of alternative risk financing is challenged by the soft insurance conditions”.

Risk managers are warned to proceed with caution when engaging in capital markets, alternative transfers and self-insurance. Meltzer suggests capital market alternatives might not be ready for the extent of damage caused by certain catastrophes. “The capital markets are used to make money. One major catastrophe and you might possibly see a number of risk options dry up,” she says.

Richard Whitehouse, risk manager with the Government of Alberta, says self-insurance programs are effective but some corporations cheat themselves in the process. “Lots of people say they are self-insured but they’re not. Self-insurance is recognizing insuring oneself is a budgetary issue and putting the money aside…others are recognizing the issue, but are treating the money put aside as a capital surplus,” he notes.

Sobeys Canada Inc. risk manager Joe Hardy is a proponent of using self-insurance, alternative vehicles and insurance as integrated risk programs. He says risk management has evolved past insurance administration and rate increases should not be a paramount concern for the profession. “We are engaged in an evolving role. We no longer just buy insurance, we’ve expanded into loss prevention specialists, risk controllers and managers of our companies’ risk portfolios.”

Cheap may not be good

He warns, however, that the cheap rates accompanying the buyer’s market may be producing a degree of complacency among risk management ranks. For instance, he refers to Y2K liability exclusions being applied by insurers to coverages which could open up a really ugly can of worms (and significant loss exposures) for corporations assuming the risk has been transferred. Risk managers need to look beyond their insurance policies and create integrated risk programs – using insurance, self-insurance and other vehicles — to ensure total coverage and recovery.

Meltzer also makes reference to Y2K, noting the insurer reaction to the phenomenon is more of a concern than any possible escalating rates. “To see that an insurer’s knee-jerk reaction is to run to the hills when a problem like Y2K develops is disappointing. What are they here for if not to cover all of the risks that my company has?” she asks.

Certainly, Y2K — in particular negotiating with insurers on coverage — is keeping risk managers busy says Nowell Seaman, manager of insurance services at University of Saskatchewan. Risk managers are playing a key role throughout corporate North America identifying liabilities emerging from Y2K and negotiating coverage with insurers. “You would hope that in this soft market, I’d spend less time negotiating with carriers. Unfortunately, the negotiations I’m undertaking with insurers is a lot like negotiating my rates in a harder market, and it’s taking my time away from other proactive risk programs that I’ve been planning to undertake,” he says.

Still, whether it is the product of fewer negotiations or a more accommodating corporate environment, risk managers across Canada report expanded roles in the day to day operations of their organizations.

Expanded focus

Risk managers have become corporate consultants in a variety of areas including finance, mergers and acquisitions, legal liability, environment risk control and human resource, with Y2K contingency planning playing a pr ime role. “Certainly the profession is engaged in change,” says Hardy whose role encompasses financial management. “The finance world is becoming a much bigger player in risk management. Security-hedging, foreign exchange issues, mergers and acquisitions…these are areas where management is asking for more feedback from risk mangers,” he adds.

Silver’s risk management department recently played a role in a company acquisition. “Management included us in the due diligence process so we could identify and prepare NOVA for the risk associated with the transaction,” he says.

Heather Zomar, the City of Surrey risk manager, says the municipality has tried to spread risk control throughout the complete organizational rank. “We’re trying to encourage enterprise-wide insurance management. We have a cross-functional risk management team that looks at how risk affects more than one department. Our ultimate goal is to have each employee be their own risk manager,” she says.

Just as important as these initiatives are the corporate philosophy being exercised. Risk management is clearly being embraced as a corporate-wide philosophy, not just a curious science exclusive to one department. “There is greater recognition of risk management at corporate board levels. Titles within companies are changing from risk managers to directors, from directors to vice presidents. And more and more officers are seeing risk management’s potential as a profit centre,” adds Hardy.

Even brokers and insurers who deal with risk managers are noticing the evolution of the profession. “Risk managers are now split into two different categories,” says Sean Mooney, economist at reinsurance brokers Guy Carpenter & Associates.

He adds, “there are the insurance people who perform primarily a treasury reporting function and then there are the more sophisticated financial managers. Typically we deal with insurance buyers but with more integrated capital-type programs, we find ourselves dealing with financially knowledgeable risk managers.”

Standards and education

With such a variety of roles for risk managers, it is no surprise the profession is apprehensive to create a standard definition for the job title. The Canadian Standards Association (CSA) is attempting to do just that, and meeting plenty of opposition along the way. The organization recently released its “Risk Management Guidelines for Decision-makers” and while the word ‘standards’ is nowhere in the title, risk managers are concerned this type of document will be interpreted as a blanket professional definition.

Meltzer argues standard definitions are problematic in an industry where no two risk mangers perform the exact same task. “If you tell [current RIMS president] Mark DeLillo that risk managers need to expand into financial risk management, he’ll tell you his company has no place for this function. In his instance, he is seeing the expansion of risk management into human resource,” she says. With risk management an accountable process with a set decision-making structure that can be applied to any business sector, Meltzer suggests industry guidelines already exist.

What is not debated is the need for universal educational requirements. While Canada already has the Canadian RIMS Institute which offers a fellowship program, the rest of the world has recently following suit. RIMS has announced the adoption of a fellowship program that adopts many of the Canadian standards, building upon the associate of risk management designation and inte- grating other specialized expertise courses into the curriculum. As part of the elective requirement, students can expand their knowledge base by studying specialty courses including human resource, economics, contract law and worker’s compensation, among a host of business-related courses.

The new standards will bridge the gap between the profession and academia. Says Norma Nielson, professor of insurance and risk management at the University of Calgary’s Faculty of Management, “the new education standards will create a stronger connection between the professional and traditional academic communities”.

Meltzer, for one, is quite proud of RIMS’s recent fellowship adoption. “The most exciting part is that it is modeled after the Canadian model. Canadian risk managers should have a lot of pride in the fact that they designed the standards that the rest of the world will follow,” she says.