Wednesday, 25 July 2012
Do insurers really know better?–Risk Distribution
Commercial Risk Europe caught up with Leberecht Funk as part of our annual Risk Distribution survey, sponsored by Lloyd’s. Discussions soon turned to the balance between risk management and risk transfer, the current state of the commercial insurance market and how brokers can best meet clients’ needs.
Friederike Krieger (FK): How did you fare in 2011 and what is your outlook for 2012? Has the industrial market become tougher or easier for brokers in recent times, how and why?
Leberecht Funk (LF): 2011 was another good year for Funk. Despite sharp competition and limited insurance budgets we grew our book of industrial business organically by more than 5%. Our estimates for 2012 are slightly lower but we have a proven record of exceeding our early expectations towards the end of the year. We are optimistic about ultimately matching the positive results of 2011 despite the overwhelming political and economic uncertainties in Europe and beyond.
2011 drove the combined ratios of most insurers adversely above the 100% mark and thus allegedly created a foundation for an underlying hardening of the general market momentum. But market reality continued to be competitive in 2011. Occasional attempts by a few insurers to increase premiums in general were simply frustrated–similar to prior years–due to an abundance of risk capital undermining underwriting discipline and a market turn. Renewals for 2012–with the exception of commercial motor–exhibited a significant slowdown of uncontrolled premium erosion.
In addition, the typical asymmetrical behaviour of insurers has started to show up again–existing clients are confronted with tougher conditions than new clients. Consequently, competition for new and particularly large volume business remained strong in 2011, demonstrating a high degree of flexibility. Calls for higher premiums led to clients changing their insurers and were finally withdrawn.
FK: Is the market for industrial insurance hardening, softening or stable in your key territories and what is the pricing outlook?
LB: We expect a diversified adjustment period towards a material hardening of the markets concurrent with a re-alignment of insurers’ risk portfolios. Apart from the availability of risk capital the pace of change will very much depend on whether the large globally active insurers find short-term sustainable relief in growth markets outside western Europe. But everyone is heading in the same direction with similar concepts which fuels competition there.
Forecasts about pricing are unreliable. Past statistics are not representative for the future, however the tendency towards hardening, as opposed to a continuing weak market environment, seems to be relatively certain. In 2012 we see clear indicators of a hardening environment such as more reluctance to quote early, to engage in multi-year policies and to take away business from competitors. Insurers are becoming more technical and are asking for more information. They refuse cover for unnamed locations particularly for business interruption (BI) risks and limit capacity, just to name some market signals.
FK: Have you seen tighter capacity and coverage terms offered by the industrial insurers as a result of big catastrophic losses suffered last year and/or Solvency II, and if so where are the main problem areas?
LB: The impact of huge catastrophe losses on the general property and casualty market is apparently marginal. In other words the ‘risk of infection’ between specific lines of business appears to be limited. Also within the sphere of elementary perils we can trace only a moderate hardening of terms and conditions, but much less than expected even in critical regions of the world. But the awareness, particularly for supply chain exposures, has grown tremendously. Again, the blending of insurance and capital markets seems to have a smoothening effect on volatile (over) reactions.
As regards the impact of Solvency II on the appetite for catastrophic risks it can only be stated that in view of the lively public and political discussions about fine-tuning the regulation and its introduction date, any influence could only be of an indirect and/or anticipatory nature. However, the (re) structuring of insurers’ portfolios anticipates in many visible ways the capitalisation rules of Solvency II. From a broker’s and client’s perspective Solvency II considerably changes the mindset and market approach to get the best deal. Many lessons will have to be learned within a less stable and predictable insurance market.
FK: What are the major risks faced by European corporations currently and how does this differ from five years ago?
LF: Objectively, not much has changed, but negative experiences and improved analysis have helped to create a different level of risk awareness and understanding. This is a prerequisite for effective risk management and calls for insurance products that buffer new risk scenarios. Yes, this industry needs to be creative and responsive to the universe of BI risks, whether global or local, to cyber, reputational and climate risks to name only the obvious ones. But we must also understand that this is not about flying a kite. Risk transfer, and in particular the assumption of unprecedented risks and lack of relevant portfolios to spread such risks, will require premiums that might not lead to deals being made.
FK: What are the major coverage gaps that need to be closed?
LF: The big question is: ‘How entrepreneurial must the insurance industry become to step in where the management capacity, vision and/or understanding of extremely complex corporate risks is too limited? Do insurers really know better?’
Many global giants can carry financially enormous amounts of diversified risks without insurance but might need insurers’ and brokers’ analytical competence for effective risk management. More dialogue is necessary, but customers are reluctant to openly share sensitive information. The biggest difficulty is not the known unknown but the black swans! And to bridge this knowledge gap is much more important than to close coverage gaps which ultimately must stand the test of being economically feasible for the parties involved.
Nevertheless we do believe that our industry can improve its value in terms of systematic analytics and even coverage for critical supply chain risks where Fukushima and the floods in Thailand, for example, have brought to light dependencies and interdependencies that surmounted any expectations. So our plea and action plan at Funk is to emphasize more structured information that enables industry to develop adequate risk management measures, forming the base for wider coverage terms. However, we expect insufficient capacity to cover the catastrophic exposures. The ‘economic test’ may not be met.
FK: Which emerging risks need better and broader coverage? What are you doing about these key areas for your customers?
LF: A broader analysis of BI risks is of vital relevance in a global economy with multidimensional interdependencies. Most companies qualify supply chain risks as critical for their continuity. Funk has developed unique analytical software that identifies and values global BI exposures. Not surprisingly, industry is responding very positively to it. Insurers have also shown interest. A well-managed supply chain risk ultimately is more apt to find individual policy extensions to cover severe repercussions following a disruption in the supply chain. We do not believe that such extensions will become standard. Consequently this is primarily a challenge for corporate risk management.
As regards cyber risks, another prominent emerging risk, a variety of coverage forms have evolved in the markets. But cloud computing, data processing, engineering and trading have a huge social impact and face critical legal restriction that cannot yet be fully taken into account. Data safety and availability, the lifeblood of any corporate venture, have become paramount issues in relation to continuity and performance. Liability risks arise for any operation relying on external service providers. Here again, the call for risk transfer solutions is evident. However the insurance markets are at a very early stage in modelling unprecedented cloud and cyber attack risks.
I hesitate to call reputation risk an emerging type of risk. Product recall and protection coverage are just two examples that address important facets of reputational risks, particularly for the automotive and food & beverage industry. A bad reputation–even more so in conjunction with the spread of social media–can destroy corporate values in such a short time that hardly any corrective action might be possible. Reputational risks therefore require extremely sensitive handling. Again, before calling for insurers to close coverage gaps, organisational and cultural measures as an essential part of corporate risk management have to be defined, implanted and controlled. Insurance gaps will continue, but eventually narrow with more knowledge of the intricacies of the world of negative reputational procedures and their impact.
FK: Are brokers fairly paid currently for their services offered to customers and insurers and how should it be improved? Is it correct that both customers and insurers pay brokers and how could this system be improved?
LF: The transactional part of our business has become smaller over time in favour of risk consulting and the design of creative risk solutions and tools. The consulting part has become more challenging and complex. We should be able to compare the content and quality of our services and thus our revenues with what business consultants, lawyers or accountants charge for. In that sense, the remuneration for our services for larger corporate clients can be called inadequate and there should be room for improvement. Transparency and quality services will help. Branding your quality performance is so essential in order to achieve this goal and to differentiate from the grey mass of traditional intermediaries.
FK: Have you had more problems with claims in the last year and what could brokers and customers do to ensure claims are dealt with more effectively and more quickly in the future?
LF: Since the scope of insurance contracts has become wider and more complex, pre-contractual conditions and information requirements have more relevance. There is ample room for arguments and to delay or deny settlement. We have not seen any indication that insurers really understand that claims management is the most effective customer relationship instrument. In fact market experience tends to support the impression that insurers first look at their ratios with claims management primarily used as a tool to achieve such ratios in a given framework. However, having previously referred to the subject of reputational risk, this is extremely dangerous for insurers. But we can see a gradual improvement. As brokers we should charge insurers for our extra efforts if claim negotiations take too long. This might be an effective measure to promote claims settlement in a timely manner.