Renewal: “An irrational preference for that which has gone before.”
I credit my Willis Towers Watson USA colleague Sean Rider for this quote, recently used in the Webinar series “Outsmarting Uncertainty”.
Renewal is embedded into our DNA as buyers, brokers and insurers. It happens every year and we all slavishly prepare for, negotiate and execute renewal transactions. In stable economic times and uneventful risk conditions, the preference for what went on before makes perfect sense. Last years’ renewal was based on healthy economic conditions; the hard insurance market was on the horizon and budgets were capable of expansion. Clearly, we do not have those conditions today. The hard insurance market and the anticipated impact of the COVID-19 pandemic have already cut deep into insurance renewals so far during 2020 and these conditions are likely to persist for some years into the future.
Time for a seed change at your next “renewal”? Bearing this in mind, your next renewal should really be the inception of a new chapter, a seed change to reflect the “new normal” of your company’s post COVID-19 condition. Consider whether your organisation could sustain a major loss today of the same magnitude that it could have done at the start of the year. Is the same cash available? Is your access to credit markets the same? Is your ability to pay dividends to shareholders and wages to staff still the same? In most cases, the answer is no, so any renewal strategy needs to be fundamentally re-assessed.
The “Gateway Workshop” So how do you go about planning the inception of your 2020 (or 2021) insurance programme? Depending upon your risk financing maturity, it should start with a “Gateway Workshop”. This is conducted with your broking team and internal functional stakeholders (including treasury, tax, finance, legal and risk personnel) in a safe environment outside the season of renewal pressures, which is designed to elicit a high-level assessment of your insurance programme and broader company risks. Ask yourself the fundamental question: “why insure?” This should tease out the drivers for the current programme and an honest assessment of your current strategy. Why, for example, are you are buying individual towers of insurance for a suite of non-correlated risks? Why do you carry a big retention for your Property programme but routinely buy project-specific Construction insurance with a low retention? (Especially when that project is yet another mining expansion – akin to “business-as-usual” for many operators.) The workshop should explore which insurance covers are really needed and which could in fact be cancelled. It should consider a 3-5-year Risk Financing Strategy with a view to what the programme could look like in five years, not at the next renewal. Most mining companies are not just focused on next years’ results but on their production plans and further expansions years into the future, so why not do the same for your insurance strategy? In the next five years, new and emerging risks will manifest themselves so your risk financing strategy should lay a foundation of risk capital to help finance these risks should they manifest. In most cases, 2-3 hours are need for successful workshop to critically assess the current programme and identify future direction and self-insurance opportunities. But in this short space of time, interesting things happen - the following are a few real examples of issues raised/outcomes:
What is clear is that there has never been a more urgent time to review your self-insurance and insurance mix. In many cases, self-insurance will be forced upon companies via increased retentions, coverage reductions and lower limits so pivoting to a position where the business controls that challenge, through a flexible and calculated approach to risk retentions embedded as part of the risk finance strategy, is certainly more desirable than an ongoing reactionary strategy. Get ahead of the problem and plan for the longer term.
Establishing tolerance With the long-term risk financing vision broadly outlined, analytical tools are going to be needed to provide insights, inform and support the strategy. Analytics will help your business understand its tolerance for risk, providing an indication of how much an organisation can withstand as self-insurance before an agreed level of materiality is reached. This is useful for internal discussions on risk appetite, recognising that tolerance and appetite may produce different results – the level of risk that the enterprise can tolerate is not always the same as management’s appetite for risk and willingness to absorb it. Finding the efficient frontier Analytics can also review the benefits of combining non-correlated risks at various levels of risk retention and risk transfer. It will find the efficient frontier – the desired point where an optimal trade-off is established between insurance cost and the impact of retaining additional risk.
Knowing the right price As a former risk manager, for me the most value I ever derived from analytics was always knowing the technical insurance price for my company’s risks. This helped provide insights as to when the insurance market was efficient to use and when it was more effective to retain risk at a business or captive level. Proving the efficiency of captive capital deployment One study I commissioned looked at the captive capital from a Solvency II perspective and included one standout number in an otherwise sobering 45 slide deck. It basically outlined the capital required by each business/operation to finance their retained risks compared to the capital required to aggregate these non-correlated risks into a captive. This was almost the silver bullet for self-insurance, clearly demonstrating (and more importantly quantifying) to management and the board the case for aggregating risks at a Group level and then retaining them in a cost effective and disciplined vehicle – the captive. Impact of COVID-19 Although the mining industry has for the most part been resilient during the pandemic, the industry risk profile is now very different. Analytics will provide decision support around risk tolerance and self-insurance, while the Gateway Workshop should provide the strategic direction and a preference as to which self-insurance tools to employ going forward. Managing “main event” risks In one workshop, we challenged a business which had a traditional and comprehensive suite of insurance lines but was exposed to one major uninsured natural catastrophe risk. We asked them whether they would consider cancelling all (non-statutory) insurance classes and purchase a parametric instrument for the one single company-threatening event. This was a perfect illustration of the “renewal” concept in action – the irrational repeat of traditional insurance policies with the “main event” risk remaining uninsured. These new “main event” risks may now include people risks (working from home), pandemics, cyber and shareholder/insider activism. Conclusion: the potential for self-insurance It is for this reason companies need to incept a new long-term risk finance strategy, one that:
Matthew Frost is Head of Risk Advisory, Australasia and Natural Resources Regional Industry Leader, Australasia, Willis Towers Watson. Matthew.Frost@willistowerswatson.com
