What to do about the greatest insurance challenge in decades

If you weren’t watching the insurance news, there was an interesting article recently. And when your insurance broker says “interesting”, you know they mean “concerning”.

The article is on insurancenews.com.au. It is about a presentation that the Insurance Council of Australia (ICA) CEO Andrew Hall gave to the House of Representatives Standing Committee on Economics. The headline: General insurers facing ‘greatest challenge in two decades’.

If that sounds like the hot air that peak bodies often offer up to government committees, you’d be right: it does sound like that. But this is not hot air. This quote from Hall shows why:

“Insurer profitability over the 24 months ending March 2021 was down 64 percent on the preceding two years, and according to APRA the entire general insurance sector only made a profit of $19 million in the most recent March quarter.”

That $19 million is shockingly low. For a multi-billion-dollar sector to be running at a fraction of a percent profit margin is not sustainable. It will not continue. Something will change. Here’s what I think will happen.

First, reinsurance costs will continue to go up as they have been over the past 18 months. This will affect the pricing models that insurance companies work from. In turn, this will have three outcomes: one, it’ll get passed on to customers for certain lines of insurance; two, insurers will simply pack up their bags and stop offering that line of insurance (which we are also seeing in certain product lines); or, three, insurers pricing certain products at a level where it makes the expense borderline unviable for clients (which we are also already seeing). 

None of this should be a surprise 

As an insurance broker, I’m already seeing all of these effects. When we get enquiries from certain kinds of businesses, it is difficult to find anyone willing to offer insurance at any price. If you read between the lines, you can see Hall saying the same things here:

“We are aware that the availability and affordability of some commercial lines of insurance for small and medium-sized businesses has become challenging.” 

If you know business-speak, you know that “challenging” often means “unviable”. What Hall is trying to do is to highlight that these rising insurance premiums are not price gouging: it’s the insurers trying to survive in an increasingly complicated world. A world in which offering insurance against many categories of risk has become increasingly difficult. However, the ability for businesses to manage risk is a necessity in a functional capitalist economy. There are two ways to do it:

  1. Transfer the risk through buying insurance policies
  2. Mitigating the risk through adapting your operations.

Given the continual shocks to the global and domestic sense of “business as usual”, it is becoming clearer and clearer that it makes sense to find a balance between the two.

Transferring and mitigating risk

A common way to start introducing more of Option B into your business is to find a risk-management expert who not only also understands your transactional environment but also understands your business model. They will be able to analyse your exposures and advise on what to do about them. When you implement those actions, you’ll still have some risks left over, of course. And it is these risks – the ones it is uneconomical to mitigate internally – that you then seek to transfer out via more appropriately priced insurance policies.

For most SME businesses – even those at the larger end – risk management and insurance is typically delegated to the Chief Operations Officer or Chief Financial Officer. But do they actually have dedicated risk-management skills? Probably not.

Of course, most businesses don’t have the financial capacity to employ someone specifically to deal with risk, but they can call on someone suitably qualified. Someone who has studied risk management and has the academic credentials to back it up.

I’m not saying this just because I am an insurance broker who has the appropriate academic credentials, I’m saying it as someone who is already seeing the fallout of the situation that Hall was talking about. 

I mean it too when I say that you must choose your risk adviser carefully. The insurance industry, unfortunately, has gone down a path of cost-based business models. The profits that keep the industry functional are derived from how customers transfer risks, rather than from advice on how to mitigate risks. In this situation, when the cost base rises, the insurer margins get squeezed and we end up with an entire sector on a knife-edge. This is what is currently happening.

If you’re adapting, so must your insurance company

I would like to think that the insurance industry is shifting from that cost-based model to a service-based model built around well-informed risk advisers working with business managers to engage with risk. Yet, if this broad change is happening, it’s happening too slowly.

To be honest, most insurance brokers don’t possess any business acumen beyond what they’re required to have as part of their license to be an insurance broker. So, there is a degree of ignorance about risk management on both the customer’s side – you don’t know what to ask for – and on the supply side – your insurance providers don’t know what questions to ask.

Our philosophy: the answer can only be as good as the question you ask.

For insurance brokers like myself who have academic credentials in risk mitigation, our role is not to force business owners or managers to decide on how they choose to engage with risk. Our role is to provide data on what their exposures are and advise on the pathways towards mitigating these – whether the be operational changes or changes to a contract of insurance.

Good risk management is good business practice

To me, these issues all boil down to ‘what is the most cost-effective way to deal with this risk?’ Is it cheaper to transfer it to a contract of insurance? If so, fine. Is it cheaper to modify your business in some manner to reduce the risk long-term? If so, great! Ultimately, the latter should be your goal (within reason). 

We are not here to use scare tactics, telling people everything that could go wrong in order to try to sell more insurance. When insurance brokers like us have ongoing relationships with our clients, we’re working with them to build a better, more stable and more resilient business overall.

Really, I am talking about giving risk resilience equal footing to profit margin in your business strategy. If your business is not risk-resilient, if it is brittle, then the profit margin doesn’t matter: you don’t have a stable operating base.

The business world of 2021 is in uncharted territory. The world is more connected, more dynamic and more surprising than ever. You can’t establish resilience in the new world by going for the cheapest quote generated under old-world assumptions. You have to be smarter than that.

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