Lloyd's and the UK risk management association AIRMIC have conducted research into risk trends and the influence of alternatives to conventional insurance. Nick Doak reports the findings.
Risk managers from companies within AIRMIC's 160-strong corporate membership, the majority of whom are FT 200 companies, were invited to participate in the survey which took place between December 1998 and January 1999. The response rate was comparable to previous AIRMIC surveys at 27%, and AIRMIC and Lloyd's believe that although the numbers are small in terms of a quantitative analysis, the replies are, nevertheless, a good indicator of risk managers' attitudes to the management and transfer of risk in 1999.
The largest group of respondents, nearly 30%, is involved in engineering/manufacturing activities but nearly as large a group fell into industries classed as “other”, which includes media, telecommunications, transport and oil/gas exploration. Other sectors involved were financial services, utilities, construction, retail and government/civil services.
Sixty-one per cent of the companies are quoted, 14% are private and 14% are UK subsidiaries of a UK or overseas parent. Seventy-one percent of responding companies have a turnover exceeding £1 billion a year and a similar percentage have over 5,000 employees.Summary of key results:
• Stress claims from employees are considered potentially the most serious developing risk, ahead of problems resulting from the year 2000.• Lack of adequate insurance cover for intangible risks, such as loss of reputation, brand/trademarks and intellectual property erosion is a concern.• At least a quarter of risk managers said they deliberately choose not to insure credit and environmental/pollution risks.
• Insurer consolidation is seen as the most important market trend in the year ahead, followed by the development of commission rather than fee based payments to brokers.
• Almost two-thirds of participating risk managers use at least some alternative to conventional, commercial insurance, the majority of these being self insurance and/or captives.
• Soft rates for traditional insurance products appear to be stifling the growth of other alternative risk transfer (ART) products.
Growth of risk significance
Respondents were asked which of the following risks they thought would grow in significance to their businesses in 1999: stress claims from employees, system failure through Y2K, loss of reputation, directors' and officers' claims, climatic, class actions, fraud, credit risk, brand/trademarks, intellectual property erosion, currency risks, genetically modified organisms, terrorism.
Of the risks listed, stress claims from employees were considered to have potentially the most significant impact on their business in the coming year. Studies by both the Trades Union Congress (TUC) and the Confederation of British Industry (CBI) support this view.
However, the replies did not show concern with finding adequate insurance cover for such risks. Organisations who seek to reduce the potential losses resulting from stress by offering counselling as part of their employee healthcare can get cover via existing insurance products.
One of the most widely reported and potentially catastrophic risks faced by UK industry is the threat of problems arising from the “millennium bug”. The survey showed 55% of participants see year 2000 as increasingly serious in the coming year.
Nearly one-third of the respondents are concerned that there is not adequate insurance cover for possible claims resulting from year 2000 risks. With reports that insurers are moving to limit and, in some cases, exclude claims arising through Y2K, the concern among risk managers of large organisations is centred on the ability of their current insurance to provide adequate cover should a worst case scenario occur.
However, 16% of the risk managers actually felt that Y2K risks would be less serious in the coming year. This suggests that some organisations are coming to terms with the levels of exposure created by potential problems and are developing, or have developed, contingency plans to cope. Another factor could be that the gathering impetus of in- house IT programmes within larger organisations will do much to defuse possible claims as 2000 approaches. It appears that risk managers are taking a rational approach to a very emotive area of risk.
Taken as a whole, issues relating to corporate reputation and intellectual property are seen as increasingly important, even though the sample had a large component of respondents in businesses such as engineering and manufacturing. The fact that these issues are at the forefront of risk managers' thinking says much about changing attitudes towards knowledge protection, and this is the area where they expressed the greatest concern over lack of insurance cover.Three of the four risks specifically mentioned - loss of reputation, brand/trademarks and intellectual property erosion - are closely associated with the difficulty of assigning a financial value to an intangible assets and it is, therefore, equally difficult to assess how much damage has been caused through adverse events.Terrorism was the only type of risk that showed an expected reduction in importance. Undoubtedly, the Northern Ireland peace agreement and subsequent downturn in mainland UK terrorist attacks are the factors underlying this result. Underwriters seem to share their views; the terrorism market is experiencing a reduction in premium rates.
Insurance market trends
Respondents were asked to assess whether the importance of a number of insurance market trends in 1999 would increase, decrease or remain about the same. The survey indicated that risk managers expect more insurer consolidation this year, a prediction reinforced by the planned acquisition of Guardian Royal Exchange by Axa, announced following completion of the survey fieldwork. Further consolidation is also expected among brokers but at a slower pace than previously experienced.
Risk managers do believe that there will be an increase in the movement of broker remuneration from commission to fee based payments. This is not a new trend but the response confirms that significant pressure remains within the insurance industry to move away from commission. On the one hand, there is a growing desire to see a transparent link between the provision and remuneration of services provided by the broker. On the other hand, brokers face commercial pressures to adapt their services to the needs of their clients.
Alternative risk transfer (ART) is an umbrella term for many products and techniques. Some are long established and not so “alternative”, such as self-insurance and captives. Others are more innovative, such as new financing techniques, derivatives and securitisation. Presently, however, while use of captives and self-insurance is widespread and growing, other ART products are still over-shadowed by traditional insurance, as risk managers take advantage of soft rates and favourable conditions. However, should rates begin to increase, then risk managers will have a wider choice of economically viable options.
A large proportion of those employing self-insurance do so via a captive arrangement, particularly among the larger multi-national organisations. Two-thirds of those in the survey expect their use of alternatives to commercial insurance to increase in the next two years. As respondents become more accustomed to the concepts of ART and sophistication levels increase, so does the interest in other ART products, particularly banking-based product types, such as finite insurance and contingent capital.
The survey also asked respondents currently using alternative risk transfer to identify the main reasons for doing so. Greater flexibility is the main business driver, and a need for protection of non-traditional risks, such as intangible assets, is the second major reason cited by respondents.
Among the risks which the participating companies choose not to insure, credit risk came top of the list followed by environmental/pollution and political risk.Finally, the risk managers were asked to indicate whether they used modelling or simulation techniques for risk management purposes and whether such use had increased in the last year. The majority of the risk managers who replied do use risk modelling with two-thirds using techniques to determine loss expectancy and just over half to gauge retention levels. Only one-third of the respondents stated that their use of modelling actually increased over the last year.Commenting on the survey, Bill Rendall, chairman of the Lloyd's Underwriters' Non-Marine Association, says: “Not only does the research confirm current and future trends within the insurance industry, it also leads to the identification of new risk requirements, resulting in a positive approach to product innovation.”
Nick Doak is manager media relations at Lloyd's.