The coronavirus continues to spread in Canada and globally, and, as a result of the pandemic, risk appetite among insurance buyers is likely to evolve. This, has implications for risk management strategies deployed within businesses, according to experts at global insurance broker Marsh.
Risk appetite is an important part of designing insurance programs and often overrides any analytical considerations, said Steve Harry, senior vice president in Marsh’s financial solutions group.
“One thing we won’t normally try and do is to build an insurance program for clients that exceeds their risk appetite,” said Harry during a webcast titled “Risk Profile Changes in the New World,” adding that risk appetite refers to how an organization feels about insurance risk and how much risk they’re willing to assume. Appetite exists in contrast to risk tolerance, which is a company’s ability to withstand shocks and is more numerical, whereas appetite can be subjective.
There are a few notable trends concerning risk appetite. While companies can be risk-takers within their business strategies, they can also be risk-averse when it comes to taking on insurance risk. Moreover, companies where insurable risk is closer to their core competence tend to have a higher risk appetite. Harry pointed to a mining company managing large physical risks that will in turn often be more confident about assuming insurance risk. Another key aspect of risk appetite is that it also depends on an insurance buyer’s confidence in their risk management approach as well as what is occurring outside of their own company.
This is where COVID-19 comes in. Before the pandemic, it was relatively easy to solve the equation of program design, noted Harry. However, risk appetite is likely to fall and the other dials that Marsh normally looks at to design insurance programs have likewise started to go haywire. These dials include the cost of capital, insurance capacity, and a company’s strategy time horizon.
If businesses are retaining more risk, they have to pay for this threat with their own capital, the cost of which is increasing. When it comes to time horizons, if a company is taking on a big risk, it’s easier to do so if they know they have more time to “smooth out the potential volatility of taking on increased exposure,” explained Harry. Now, many companies are looking at their short-term horizons and ensuring they have liquidity over that timeframe versus the longer term considering the uncertainties brought on by COVID-19.
At the same time, businesses are also imposing more control over their costs and have a reduced insurance budget, all while the insurance market is seeing global average commercial insurance prices spike 14% in Q1 – the largest increase since Marsh’s Global Insurance Market Index was launched in 2012. As a result of these factors, companies have both a reduced risk appetite and want to buy more insurance while also having a reduced ability to buy as much insurance as they want.
However, the same isn’t true at every commercial insurance buyer. It’s a good time for organizations to revisit what their insurable risk appetite actually is since the same trend won’t be reflected across the board at every firm. Each sector has, after all, been impacted differently by the coronavirus, as have individual companies.
“We’ve seen a lot of caution in our client base, but we’ve [also] seen a couple of clients say to us, ‘actually, I’ve always known I could retain this risk. This is my time. I’m going to get a good payback for retaining it now,’” said Harry, adding that businesses need to consider what’s happening to the cost of their capital and what sources of capital and liquidity they have while considering the time horizon they’re working with. “Over the short term, paying your own losses tends to take longer than paying out insurance premiums so sometimes an increased risk appetite could have that short-term payback just with the fact that you won’t have to pay losses for a little while.”
With the help of their brokers, businesses should also analyze their risk portfolios and ask themselves which risks they have that are insurable and exceed their risk appetite.
“It’s a mass generalization, but we see people buy too much cheap insurance and probably not enough expensive insurance,” said Harry, noting that insureds should consider, “Where is risk transfer providing value in your program, and where is it providing the most value and where is it providing the least value?”
If companies have a limited risk appetite, they need to deploy insurance programs where they can get the most bang for their buck. They can also review what other risks they might be facing down the road – since the pandemic has clearly revealed that many companies had a risk they weren’t aware of – and adjust their risk strategy accordingly. Modelling risks and risk appetite can help companies move ahead with all of these steps.
“Overall, we think the important things here are to get some science behind the process and to establish a procedure that will stand the test of time, [to] document what you’re doing and to come up with a process that makes sense,” said Harry. “At a time of crisis like this where all our dials are changing faster and things are moving quicker, we think it makes even more sense to have that science and that agility behind understanding how you deploy what might be a reduced risk appetite.”
