INSURANCE FUNDS
The management of risk
Gillian O'Connor
It is barely credible that any industry can sit back and watch itself losing money for almost a solid decadeYet this appears to be just what has happened to the British insurance industry, which has lost money on its basic underwriting business almost every year since 1961. In almost any other business the companies concerned would either have closed their doors, or taken radical steps to restore profitability earlier. How is it that the insurers have apparently taken so long to wake up to the need for action, and what trends have resulted from these actions?
One point which must be made in defence of the industry is that insurance is not a business which can be turned from losses into profits overnight. The time interval between the payment of the pre mium and the final totting-up of claims costs means that it is almost impossible accurately to predict losses until they have actually occurred and of course inflation has boosted the claims bill meanwhile; and remedial measures equally take a long time to be reflected in results. The other point is that not all classes of business or all areas of operation have done badly all the time: it is just that the losses appear always to have outweighed the profits.
But even if one bends over backwards to be fair to the insurers, the record is bad.
One of the major explanations for this apathy could well be the very thing which has been their salvation — investment income. Even in a very poor year, the in dustry as a whole, and all its members (with a few notable exceptions), still made handsome profits from the income from invested premiums and accumulated reserves.
With this comfortable buffer between themselves and bankruptcy, it is hardly surprising that many of the insurance com panies were tempted to take the complacent line and reckon that growth in in vestment income made underwriting losses acceptable. The rationalisation was that if any individual company raised its premium rates above the average, it would price itself out of the market, and thus lose the premiums and investment income which were its one reliable source of profit.
It would be unfair to claim that this complacency has been universal. Within the limits of market competition, many of the companies did their utmost to get their underwriting on a profitable footing during the 'sixties. And aggregate losses of nearly £70 million in the last two years of the decade shocked the others into realisation of the necessity. The trends within the insurance industry which have emerged are mainly evidence of this campaign to start making money on underwriting again, and stop the erosion of reserves which has resulted from undue reliance on investment income. Once the really bad business has been weeded out, the most obvious move might appear to be to increase premiums sufficiently to leave a margin of profit after claims and expense costs. And customers who have seen their motor premiums soar in the last couple of years may well reckon that this is all that the insurance companies ever do. In fact they have all been devoting considerable time and effort to keeping both claims costs and operating costs as low as possible. For reduction in these two key items means that even if premiums do finally have to go up, the necessary increase will be less. First for claims costs, which normally account for some 60-70 per cent of premiums (though with wide fluctuations both sides of the average in particular risks and classes of business). Reducing claims costs does not mean failing to give policyholders a fair deal — for that is hardly the way to build up a good reputation. What it does — or at least should — mean is reducing the likelihood and seriousness of claims in the first place; and in the second, seeing that the cost of meeting them is not unduly inflated by outside factors — as when garages reckon that for an insurance job it is reasonable to add 20 per cent to the cost of the repair. Risk management and risk improvement are the new 'in' words in insurance. The concepts themselves have been around for a long time. And the "prevention is better than a cure" tag has accompanied all the insurers' attempts to check fire wastage, and all other accidents which can lead to an unnecessary claim. The trouble is that risk improvement all too often has disadvantages for the customer. Car owners find seat belts a bother, and similarly industrialists complain that the type of safety measure promoted by the insurers (such as partitioning buildings so that fires cannot spread) are precisely the type which hinder efficient production (such as continuous assembly lines). This is where the risk manager comes in, at least in industry. The risk manager operates from the fundamental premise that any major insurance claim will result in an overall loss to the customer, since even if the claim is paid in full (including compensation for the interruption to business) the company will still lose out on things like opportunities lost to a com petitor, and vanished market shares. Thus the industrial customer should be concerned not so much to make sure that all risks are covered, but to see that as far as possible they do not exist (even if this raises costs on other parts of the business) and insurance should be left as a last resort to cover the residual risks.
Few would disagree with this basic concept, and where the disagreement does enter the picture is on who should doing the risk management. The big,, surance companies in some cases that they should, and have placed lac-,° ing emphasis on the possibility of IA dustrial companies 'going direct passing insurance brokers (and their; missions) and allowing the companies, to advise on risk management and full insurance for the residual risks, If the insurers have full control e'le risk management of the businesses„t insure, they have only themselves to if claims costs get out of contr°1 " direct " business also means a subs reduction in running costs, airiceii brokers normally get 10-20 per cent of total premium. On the smaller side insurance scene, the companies havis been trying to reduce claims private motor business. The Brit',56 surance Association has establiP, motor repair centre (in conjuncti°1 Lloyd's) which is designed to Pr'd standard cost for standard repairs, which inflated claims from inclePnot garages can be measured. And ssi,o; the companies also have approved garages whose charges are deemed able. At the same time the insurers havei seeking various ways of keeping v. their running expenses. One of t11%, which has bothered them is the aril,:te, work which they do which is duP11'7,0 the insurance brokers. The sugges' been made that where brokers volved, they should concentrate 0;f management advice, and leave an me administration to the insuranc" panies. This would reduce the aof brokers could reasonably claim in e„ sion (and they could even work c).;',‘ basis), and thus cut the insurers' emo But not all these running exPede, forced on the insurers from outs,' o' insurance industry employs a fiftV total labour force in the city af and rising salary bills have been drltip; key items forcing up their opers,i'e penses. The merger round of t'io 'sixties was one of the ways of c(iivp' this trend, and several of the 00( have made efforts to reduce staff lie and increase productivity since tilt# incursion of ASTMS may mean scope for doing so in future IS to' Computers are being increasinglYa in to take over some of the ",'" work. And even the amount a' work involved has been cut bY troduction of the 'packaging This means that where possible '4de panies have endeavoured to persito their industrial and their small c" to wrap all their insurances °Poi single bundle instead of taking °lid expensive and time-consuming fs9ti1l different things — which could s the customer without cover in °id( aspects at the end of the day. Ttle0 also been mooted that insurers 5'.0' into the'" financial supermarket n g co-operate with similar organ'asttv tiCfr.
as banks and HP companies, s° possibility of expense reduction expanded even further, but as remains very much an idea ratile
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