As I sit here contemplating thisarticle, I can’t help but sensethe changing winds. It is muchcooler outside this morning witha hint of Fall in the air. Footballseason is getting into full swingand the anticipation of the comingpresidential election is growing.
Along with the normal andexpected changes to which we’reaccustomed, there are some noteworthychanges happening in theeconomy and financial markets.Over this past weekend, a majorfinancial institution was acquiredby another, a major financial institution filed bankruptcy, and arguablythe largest insurance company is scrambling to right the ship. Wehave all heard about the mortgage crisis the country is experiencingand the recent record fuel prices. When you add the damages fromnatural disasters such as hurricanes Gustav and Ike, not to mentionthe other regional natural disaster, I believe the winds of change in theinsurance market are blowing.
Many would consider the recent changes negative. Others wouldconsider them a positive step towards a more stable economy. Whilewe certainly don’t wish hardship on anyone, many of the financialchanges were necessary, and will lead to some arguably much–neededcorrections. The economy has been very robust for a while now andis apparently experiencing a period of contraction that will help tobring back some equilibrium to the equity, credit and insurance markets.
What does all this have to do with managing risk? The impact ofthe natural disasters is obvious. As natural disasters occur, insurancecompanies have to pay claims and that reduces their reserves. Theimpact of the financial challenges may not be so obvious. Over thelast few years, insurance premiums have been declining every yearfor most property and casualty insurance buyers. This trend has continuedfor a while now as insurance carriers try to maintain and growtheir market share. In an effort to write new business, many carriersmoved away from maintaining underwriting discipline and have loweredtheir premiums to unprecedented levels. This reduction in underwritingdiscipline and aggressive pricing has resulted in reducedunderwriting profits. Most of the insurance companies have beenable to make up the underwriting losses with investments in equities,loans and real estate. Now it appears those markets are struggling toprovide sufficient returns to cover the underwriting losses and providesufficient returns for the shareholders.
With the uncertain climate of the national economy and therecent catastrophes, we should expect the soft insurance market towhich we’ve become accustomed to begin to firm up. As the insurancemarket begins to firm up, the insurance underwriters will returnto looking at an insured’s operations and claims experience in relationto premiums paid. When carriers begin scrutinizing insured’s operations,they will look closely at their risk control programs, the typeof industry, management attitude towards safety and peer to peerbenchmarking data. Most of this is standard underwriting scrutinythat all insureds should expect and prepare for by properly managingrisk throughout the year.
The tricky and unexpected part of a firming market is the effectthe soft market has had on many companies’ loss ratios. A company’sloss ratio is the ratio of claims incurred to premiums paid. Since manyinsureds have experienced drastically reduced premiums comparedto a few years ago, but have not experienced a relative reduction inclaims incurred, their loss ratios have increased substantially. This hasnot been as much a factor in premium calculations since companieshave been willing to fight for market share by giving discounts in spiteof high loss ratios. However, as the market continues to firm, morecompanies will begin to take a harder look at an insured’s loss ratiosand use them as a key factor in calculating premiums. When that happens,insureds that have become accustomed to the soft market maybe in for a rude awakening.
Because of this, I believe it is imperative that insureds focus ontheir total cost of risk whether the insurance market is experiencing“soft” or “hard” conditions. A total–cost–of–risk approach is the onlyway to minimize the wild fluctuations in premiums experienced byinsureds that only focus on premiums. By managing your total cost ofrisk year round, whatever the market conditions, your company willexperience more pricing stability during both hard and soft marketsand have a distinct advantage over your competitors. It is critical thatyou manage your total cost of risk throughout the year, and not justat renewal time by trying to negotiate the cheapest premiums possible.You and your insurance broker need to position your companyto negotiate your renewal terms from a position of strength. If youwait until renewal time, you will be at a distinct disadvantage and atthe mercy of the insurance market and carriers that may offer you aninsurance quote.
Consider risk management as an important and integral part ofyour business, and not just another necessary evil. You’ll be thankfulyou did.
