The recessionary environment has provided a solid stress test for many risk management programs, leading to a realization that despite our collective best efforts, opportunities for improvement still exist.
For example, there is no doubt the recession presents important lessons for anyone playing a role in property risk management.
Let start by examining a fundamental precept in articulating the value of insurance–coming to an accurate assessment of the total cost of risk (TCOR) for an organization or enterprise.
Most TCOR calculation methods consider such costs as premiums, risk control and loss prevention expenses, self-insured retentions, or deductibles and risk management administration costs.
As the global economy struggles to recover, TCOR provides risk managers with a quantifiable standard for measuring risk and an unbiased means of communicating risk metrics with corporate and financial leaders.
The risk manager of the new economy will need to demonstrate an acute understanding of each risk expense, delineate between compliance and discretionary spending, as well as be prepared to defend the effectiveness of every term, condition and service purchased.
A familiar refrain has crept into many property renewals over the last 12-to-18 months–property and business interruption values need to be submitted with greater accuracy and supported by logic and thoughtful measurement criteria.
Additionally, those values need to be based upon an organization's prior experience and likely expectations for the future–often challenging to assess in practice.
ASSET VALUES
Property valuations have fluctuated along with the volatility of the worldwide markets. An organization relying upon values established more than 24 months ago needs to reconsider a number of factors–including the impact of construction costs, material prices, equipment and technology advances, as well as energy prices when presenting replacement cost estimates to an insurer.
Underwriters are scrutinizing submissions for calculation methodology and evidence of a reasonable valuation approach. Therefore it is critical for a policyholder to present accurate replacement-cost values–the cost to replace an asset with one of like kind and quality–in the same or similar location.
Best practices emerging from the economic recovery suggest policyholders are evaluating the costs of property insurance by focusing on values. Businesses, both large and small, are:
? Having property holdings professionally valued on an annual basis (at a minimum).
? Recognizing long-term historical trends in replacement costs, which tend to rise over time, while acknowledging local trends and conditions.
? Providing more information to underwriters for the replacement costs for unique property asset profiles.
? Avoiding sweeping generalizations about coverage based simply on perceived market conditions, a lesson learned from the questionable performance of some policies in the event of claims made over the past 18 months.
A word of caution is that premium rate reductions are obviously desirable, but risk managers need to understand the consequences of lower prices on policy terms and conditions.
For example, some businesses with assets in Chile are learning the differences between percentage and unit of insurance deductibles–the former is more common (generally 3-to-5 percent of total insured value), while unit of insurance specifies a deductible for individual exposures at each location insured.
Savings on premiums may impact the extent and scope of coverage. These consequences need to be considered as part of TCOR and managed as part of a risk program.
BUSINESS INTERRUPTION VALUES
Accuracy in projecting business interruption values is no less important than valuing tangible assets and is in many ways more complex.
Indeed, many risk professionals agree that business interruption worksheets are one of the most frustrating practices in property insurance.
The completion of this worksheet is complicated by required input of the finance department and the often inherent dismissive treatment of insurance-related matters. The generic business interruption worksheet simply does not suit the complex requirements of today's organizations.
The process of valuing physical assets allows for site inspection. On the other hand, valuation of business interruption is viewed as intangible by some financial leaders. It is essential to acknowledge and identify the link between the recession and its impact on the business interruption values of an organization.
The recent economic turmoil has had a considerable impact on the top- and bottom lines of most organizations. This, too, must be reflected in the values provided to underwriters.
It is far too simplistic to suggest that a replication of the prior year's values will translate in today's more challenging economic climate.
AND FOR THE GOOD NEWS
These are challenging times, but there may be a silver lining, considering that a reduction in revenues during the years 2008 and 2009 will, for many, result in a proportionate reduction in the values declared to underwriters.
An argument can be made that reductions in business interruption premiums, or an improvement in terms, may be achievable.
Often risk managers are burdened with the task of reducing their organizations' overall insurance spend, with the immediate impulse being to reduce brokerage fees.
A detailed analysis of recent business interruption values, however, may equate to a substantially greater reduction in the TCOR.
OPPORTUNITIES AHEAD
The global recession forced a renewed, vigorous evaluation of costs and expenses in every sector, in every industry, at every company. The insurance industry is no different than any other–consumers worldwide are assessing the value they receive through insurance or any other risk-transfer method.
The most successful risk professionals will be able to articulate the value they receive for the premiums they pay.
Armed with a good understanding of the values of the assets they seek to protect, premium discussions with underwriters are more compelling and enable companies to distinguish risk profiles from competitors.
Risk professionals will concurrently develop and implement risk control strategies that ensure compliance with regulatory standards and that maximize the return (in terms of TCOR impact) on invested capital.
Neil Harrison is group managing director of Aon Global Risk Consulting in Chicago. He may be reached at neil.harrison@aon.com.
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