Mitigating risk through the purchase of insurance is a tried-and-tested method used by organisations. But picture the day when organisations must compete with each other for insurance capacity. This may not be far away. Several different factors in the insurance world are causing capacity to shrink (hence price/premium inflation) and this may create a problem for companies that don’t understand their risk as well as their competitors do.
This is the prediction from Dr Anthony Valsamakis, CEO of Eikos Risk Capital Limited, a London-based strategic risk management and insurance consulting company, and a director at thryve. Sean Pyott, thryve’s managing director, chatted to Tony about his warning and what companies should do about it.
You believe there may soon be a capacity squeeze in the insurance market. Could you set the stage for why you make this prediction?
If you look at the balance sheets of insurers, albeit that they are strong (subjected to Capital Adequacy requirements) insurers are collectively imparting the message that their Income Statements are under pressure – the 2020 financial year London market results show an average combined loss ratio of 103%, with none below 94% – for an insurer to be sustainable in the long run, this ratio needs to be around, say, 85%
As an analyst, I have some sympathy. They have been subjected to large claims reflecting the risk volatility we are all subjected to – and this presents obvious strain on their results. But, to the extent that their infrastructures and delivery costs are prompting premium increases, I have less sympathy. They need to rectify any cost inefficiencies and present a competitive front – for the past three years in a row, they have bumped up premiums such that even if one presents a ‘claims free renewal’ one still experiences insurers demanding a premium increase of around 15% to 20% depending on the risk class one is looking at. My clients have thus experienced a total price inflation of some 50% and more over a 3-year period for their essential Property and Business Interruption covers.
But many industries raise their prices annually.
Yes, they do, but not quite like this. Can you imagine, say, a manufacturer presenting its customers with a repeating annual increase of 20% per year for its commodity? There would be great difficulty in substantiating this – I feel Insurers are oftentimes naïve about the reality of their client base and the competitive pressures they face. They don’t understand that these increases are difficult to sell.
As mentioned earlier, rising loss costs for Insurers are inflationary but this is not the only factor exerting pressure on premiums. The other factor that affects their profitability is their internal infrastructure and delivery costs. I firmly believe that there’s going to be a shift soon: the ‘Amazon’ of insurance – it hasn’t landed yet but there are initiatives afoot – as one keen investor told me, “insurers’ inflated infrastructural and delivery cost represent my opportunity.’’ Costs in the intermediation equation are high – imputed in the premiums paid by corporates but not so visible. The insurance sector needs to be looked at very, very carefully, and it needs to change – soon.
So, on average, the industry’s margins are narrowing – what’s the implication for clients?
Yes, so many insurers ‘fix’ the problem by being more selective about the type of risk they will allot their capacity to. Paradoxically, whereas insurers previously competed for clients’ business and pitched their individual prices or premiums, the situation may reverse: where corporates are pitching their risk profiles, risk management and loss exposures to insurers in the hope of gaining coverage! Can you imagine? And if you think this may be far-fetched let me remind you of when banking was about deposit taking – the model is quite different now … ever tried opening a bank account? There are pre-set criteria around size, fee earning characteristics etc., and if you don’t qualify, well, good luck to you!
This kind of thinking is emerging among underwriters with stressed margins. And there are many of them. But here’s the kicker. The most significant risk treatment mechanism for corporates historically has been transfer of risk. The importance of transferring the risk to an insurance sector is still the most important activity that they look at, right now. To the extent that capacity will become selective, expensive and less available, this will pose a structural headache for companies looking to mitigate risk.
In this scenario, it is not unlikely that insurers may only give capacity for the non-predictable or volatile risks – attritional losses could become a business risk and uninsurable. That’s one criterion. Another could be not giving capacity if it is deemed that risks are not being managed effectively – and to a standard acceptable to the insurer.
We’ve reached the crossroads. Our clients are going to have to compete for capacity and they’re going to be having to do some things internally in order to qualify. So, what does that mean? If you are going to have access to less capacity, you will retain more risk. That means you need to understand your risk much better and prepare your balance sheet for this increased risk retention.
What do you mean by better understanding risk?
Let’s draw a parallel with a manufacturing company. I can bet my bottom dollar that they have studied production costs to the n’th degree. They know exactly what goes into the cost of sales, they know what their marketing costs are, and so on. They can get to the parameter of gross profit, net profit, and anybody who has been in business for a long time would have a very good handle on the individual component costs of whatever they manufacture and supply.
Now, similarly, you’re going to have to be as accurate on each risk factor your organisation faces. You’re going to have to build in, not only production factors, but risk factors, because you’re not going to be able to transfer that risk easily into the market.
The type of attention to detail that would appear in any cost accounting regime now has to appear when one considers ‘event risk’. And the data that supports every activity within the company has to be at their fingertips with regards to risk, exposure and losses (actual and potential).
How can companies create that detail?
If the underwriters won’t quote on complex risks without data or details, the onus falls on consumers of insurance to be able to present their risks in a way that makes the complexity easier for insurers to understand. In the past, it was the role of the broker to present insureds’ risks to the underwriter, but the sheer amount of data and complexity means that consumers/customers need to take greater ownership of their own data. Technology platforms are the solution to managing and understanding risk within the business at the same level as a cost analysis for production, or whatever example you’d prefer. If they want to secure access to a finite insurance market’s capacity, they need to know more about the risk and exposure they have, how they can mitigate those, and how they can present their risk data to insurers in such a way that they persuade underwriters to provide scarce insurance capacity.
An integrated risk management platform such as Riskonnect, will enable risk managers, not only to better understand their risk exposure, physically and financially, but also present this data in a meaningful way to insurers in a competitive market. In a beauty parade it is incumbent on the business to help insurers understand their risks, and to present their risk management strategies and risk profile in the best possible way. By having complex data available in a format that is easy to model, a business becomes much more attractive to the potential underwriter. All businesses need to understand their risk at the same nuanced level that they understand everything else in their businesses.
So, is capacity shortage permanent?
While capacity shortages may not be a feature in the long-term, it is likely that in the short and medium term we are going to see a continuation of the harder market due to income constraints and a different underwriting risk appetite compared to the past.
In the years to come, fewer insurers are going to cover predictable risk because it’s not cost efficient. This has a real impact on the organisation’s balance sheet. As supply goes down, the demand for that capacity is going to change. The present demand for a shift in approach in my opinion is not temporary, it’s a sign of things to come and the world of insurance and risk management has changed, permanently. It will be up to customers to use better risk management and improve their position.