Opinion by Craig Kent, head of risk consulting at Aon South Africa.

In the intricate practice of risk management, a perplexing paradox unfolds where organisations engage in risk management practices that replicate their previous risk strategies, and still expect a different or improved outcome. Sometimes the cost of consequences is left to chance, perpetuating an 'ostrich effect' where it’s hoped that somehow cutting costs on essential risk management principles will yield viable savings. The perennial truth is that cutting costs on risk management will inevitably prove more costly in the long run, sometimes devastatingly so.

In risk transfer or insurance, insurance premiums contribute towards a large portion of the overall risk management costs, making it essential for organisations to manage their premium pay-aways efficiently. Unfortunately sacrificing good risk management practices, compromises the desired results due to the risk taker’s lowered perception of the organisation’s risk maturity. Instead of cutting back, the emphasis should move towards crafting a positive narrative, and better articulating and demonstrating your efficient risk management story to the insurer, to achieve the desired risk transfer results.

To script a different outcome, a better story must be told, requiring a novel approach and inputs that demonstrate how, rather than by simply paying higher premiums, organisations can apply their risk spending more efficiently across their Total Cost of Risk (TCoR).

Back to Basics: The basis on which insurance premiums are determined.

In essence, insurers find efficiencies based on the law of large numbers with diminishing returns. In other words, the greater the pool of a class of risk, the greater the event data and the greater the chances of the particular risk being underwritten correctly. As a result, terms and rates are driven by risk and data profiling.

Insurers have access to a great deal of data ranging from the average cost of buildings through to the average value of contents, the building and contents age, average claims per class and average loss limits, providing the underwriter with the means to write certain classes of business according to predicted rates and capacity limits. But it also means that your risks are getting rated based on everyone else’s data which means that you end up with an average policy, with average rates and average terms, if average cover is available.  None of this is based on your unique risk profile and accompanying risk management story and practices.

Effective risk management allows the organisation to adopt and follow a resilient and resourceful risk management program that is continual in nature, and flexible in practice. It optimises the organisation’s response to changing market conditions to achieve business risk management objectives efficiently, and to remain resilient in the face of evolving risks. The result is that your business – with the aid of your insurance broker and risk advisor - can provide accurate chapters of your business story to influence positive risk profiling outcomes – both internally on your retentions, and externally with your risk transfer model.

The difference that a risk manager can make.

Your broker supports your business in telling your risk profile story to the insurer. However, they are limited to the information that is provided and function more effectively when the specialist risk manager of your broker is given the tools, funds and mandate through an integrated risk program to assist in shaping a different positive narrative of your business risks and its mitigation. It allows your business exco and the board to make better informed decisions that can be worked into your business risk program before going to market. This enables your broker and risk manager to put a strategy and actions in place that tell a story of resilient and flexible risk planning that delivers improved and efficient risk management results. 

It is this risk management storytelling that is imperative for considered results, specifically in the insurance market where rather uniquely, the buyer (your business) has to sell itself to the seller (the insurer). The buyer’s profile (your risk story) determines the price and principles that the sellers (the insurer) is prepared to entertain.

A practical application of risk management storytelling

Much like estate agents and marketing gurus who have been practicing and preaching staging their wares for centuries, presenting business risks to the markets should arguably follow the same concept, save that, clear and full disclosure of the risks that threaten their business be presented based on facts, applying the risk mitigation strategies to paint the positive picture, to achieve the best results.

Some examples: 

• One could declare having sprinkler systems in all high-value and high-fire load facilities, in addition to adding records of six-monthly independent sprinkler inspections supporting the declaration and any corrective actions effected.
• A business could declare they have Business Continuity Plans (BCP) and support the suitability of it by providing a recent report of a gap analysis by an independent specialist, plus any supporting corrective actions taken.
• The operational and strategic risk measures that a board have in place, makes it more palatable for the business to voluntary take on more risk through increased deductibles and finding alternate risk transfer mechanisms to protect the higher deductibles, resulting in a reduced total premium pay away.

The same concept applies to how your business shapes its risk management process, the decisions the board makes as well as how your broker presents the risks you choose to transfer, which ultimately determines how that risk profile is interpreted by the insurance market. The value of having comprehensive BCPs would be determined during this process, as would the value of having sprinkler protection and the need to allocate funds to pay for these interventions, in order to tell a better story.

Placement playbook example:

• A client secures property insurance at a premium of R25m per annum including broker's commission at R5m to provide insurers with all relevant details to ensure a good placement (approved by the FSCA).
• The client negotiates a fixed fee with their broker at R1.5m, such that the balance of the R5m broker’s commission is rebated to the client, effectively saving the client R3.5m.
• Let’s add: Rate increase trends in the last five years at 10% per annum with a claims trend above 60% of the Nett premium into the mix, but the client’s declarations stay flat for five years.
• Mid-term into the five years, the client experiences a serious event that results in a R40m claim, which pushes the claims ratios across the five years to 120%.
• At renewal, the insurer applies a 20% rate adjustment and imposes a deductible of R5m for each claim (up from R1m in the previous period), wiping out the initial R3.5m saving and adding new exposure to the company’s balance sheet due to the higher deductible.

Basic insurance principles apply. If the business is asking the insurer to accept R1 for a R1k risk exposure relief, they will need significant data as well as a significant book for that class of risk to accept R1 (as explained previously on the basis on which insurance premiums are determined).

Now what if we wanted that to be R1 for R5k of our risk exposure, or even R1 for R15k of our risk exposure? Is it possible?

The answer is: Absolutely anything is possible, subject to being able to tell a better story to the underwriters, to prove the risk of R15k is worth a risk premium of just R1, based on evidence of the risk being better managed than the average. This then goes beyond what general data and the claims trend may suggest. The buyer needs to be more attractive to the seller if the buyer hopes to negotiate the seller's offer. Having the correct data available that is extracted through an effective risk management program will provide the grounds upon which the insurer can offer more favourable terms to a more palatable risk.

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