Risk Management

A recent, very well-written article with great points, “Why Prevention is the New Protection,” by Daniel Grimwood-Bird, prompted me to write this article. His points are dead-on accurate about how a majority of auto accidents are almost 100% preventable with the right risk management tools.

​Excluding catastrophe losses, almost 100% of property claims are also preventable. Even catastrophe claims can largely be mitigated, minimized, or eliminated. And yet carrier pricing gives a great indication of why risk management is ignored by insurance companies. The best example I have is the discount given to buildings with risk-mitigating properties, such as roofing material largely impervious to hail. The 1% credit I’ve seen does not give adequate pricing relief. Carriers would prefer not to insure these buildings, regardless of the dramatic decrease they’d pay for a hail claim.

Good-hearted people in the industry seem to think of risk management in a silo. In other words, risk management is smart only if the company can benefit by knowing how to price mitigated exposures so that it gains enough new premium to offset its premium loss on the existing book. In other words, if a carrier has $1,000,000 in premium and all insureds converted to a technology that made them much safer drivers, that premium might decrease 10%, to $900,000. Businesses do not like to report decreases in revenues regardless of the reason. Therefore, the carrier would need to write more than enough new accounts to offset that $100,000 decrease.

A critical additional aspect is that the pricing likely cannot give policyholders full value for their risk mitigation. To partially offset the revenue reduction, if executives are willing to go that far, they must increase the profit margin. Therefore, if a 10% rate reduction is justifiable, the carrier likely wants to give only a 5% credit. These are examples only, but a 5% price difference is usually not enough to generate enough new sales given all the other variables involved. To make risk mitigation adequate to cause a material increase in quality new insureds, the value likely needs to be at least 15% so that the carrier can create a price differential of at least ten percentage points over the competition, all else being equal.

A 15-percentage point underwriting advantage for risk mitigation is a tough hill for many to climb. And then the question is: “Is it worth it?” How long will that competitive advantage last? Does the carrier have everything else required to successfully use this strategy?

Even if all these points are answered affirmatively, the bigger picture is that risk management still very often does not work to bolster carriers' futures. Look at workers’ compensation, where a safer work environment and smarter regulatory and litigation environments have resulted in huge decreases in premiums over the last ten years. If the entire industry realized these results across all lines, many insurance companies would cease to exist because there would not be enough revenue to go around, compounded by many carriers lacking the technical ability to adjust to this new environment.

Insurance companies benefit from expected, within reason, claims. Provided claims activity is sufficient to cause rate increases, they can always show revenue growth. Their profits do not suffer because they pass on losses to all their customers through higher premiums. Carriers screw this up when they decide to take large rate increases all at once rather than a little at a time, but overall, spreading premium increases across all insureds, because insureds ultimately pay claims through higher premiums, carriers have a pretty good revenue and profit stream model.

If 50% of auto claims are eliminated and even 25% of property claims are eliminated, how many carriers are required? Also, if preventable claims are largely minimized, do people really need the same kinds and amounts of insurance they have now? In property, the answer is easy: Absolutely Not! Consumers could take high deductibles on everything and immediately minimize their insurance premiums. This further reduces revenues and would eliminate some more carriers.

Where risk management is truly valued is in high-quality alternative risk management strategies. This is why so many commercial insureds have migrated to these strategies. Lots of variables affect a company's decision about whether alternative risk management is their best risk-transfer option. But if one can significantly reduce their probability of a claim, alternative risk management becomes quite attractive because these markets, when done well, reward insureds for being safer at levels standard markets do not appreciate.

This leaves adverse selection in the regular market. Adverse selection often includes insureds who do not care about risk mitigation. That is anathema to many, but it is a human reality. The more bad risks in any given market, the less the rates can keep up with rate needs. That becomes a vicious cycle and is likely already affecting a few carriers that cannot seem to make a profit, regardless of the overall insurance market.

I am excited about all the high-quality risk management tools that now exist. I want every insured to pay attention and take all the steps they can afford to mitigate their exposure, because never having a claim is better than having one, even if it is paid without friction or frustration. But no one should count on carriers suddenly becoming gung-ho about risk management other than going through the motions, because it is not really in their best interest. Now, if you can find just one company far smarter than all others strategically employing risk management, hitch your wagon because they should realize unreal success over the next 60 months! 

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NOTE: The information provided herein is intended for educational and informational purposes only and it represents only the views of the authors. It is not a recommendation that a particular course of action be followed. Burand & Associates, LLC and Chris Burand assume, and will have, no responsibility for liability or damage which may result from the use of any of this information.

None of the materials in this article should be construed as offering legal advice, and the specific advice of legal counsel is recommended before acting on any matter discussed in this article. Regulated individuals/entities should also ensure that they comply with all applicable laws, rules, and regulations.