“Both insurers and insurance intermediaries need to fundamentally rethink how risk is assessed”

Not my words but those of Achim Bauer, Partner in PwC’s Insurance Practice. I will be really surprised if any more than 1% of industry “leaders” have read these words before, even though they appear in an industry report that was released in early 2010.

Perhaps it would have had greater impact had it been distributed to shareholders in major insurance firms. Because, whilst they may not be risk experts, they are unencumbered by traditional techniques, engrained belief systems formed over many years and justified (not validated) by decades worth of risk data.

Financial Services has a great technique for dealing with “the inconvenient truth” when it comes to risk and other people’s money. It is something that Ostriches are known for and is the perfect position from which to claim that some major, traumatic, loss event was “unforeseen”. Then, after the event, blame another feathered friend: the Black Swan.

It is worth remembering that unforeseen does not, necessarily, mean unforeseeable.

If you are wondering why I casually dismissed “decades worth of risk data” that is because, in terms of the modern business environment, if it pre-dates the advent of the “digital decade” it is, at best, unreliable and, at worst, downright dangerous.


In short, the inter-connectedness that underpins our globalised economy and brings the impact of natural disasters, terrorism and Geo-political unrest across the planet into our living rooms, supermarkets and onto our forecourts (butterfly effect) has undermined much of the statistics that  indicated whether an event is deemed low or high probability and impact.

The realisation that everything on the planet is part of multiple inter-connected dynamic systems has a significant impact. Hence the rise in studies into Complexity.

Rather than delving too much into complex systems (there are plenty of articles in this blog!), for a brief insight, follow the link: complexity facts

If Actuaries, underwriters and brokers don’t know what complexity is or means, don’t have the tools to identify or measure it, then they aren’t able to: advise their customers about how to manage it; can’t rate it; won’t provide any protection…so UNLESS you turn to Ontonix for some assistance you are on your own.

Our mission is to help reduce global complexity NOT to get-rich-quick!!!

Mactavish Consulting report

For what it is worth I have written about and quoted this (and subsequent) research on previous occasions but this time I will leave readers to their own devices, to extract and interpret as you see fit. It should not make for terribly comfortable reading to anyone within the industry or who has assumed too much of their broker or insurer.

I don’t have the full report but if you would like some of their key findings from research into UK manufacturing, construction, retail and financial services sectors, mainly with turnovers between £50m and £5bn please drop me an email:

The research, which has been reviewed by the insurance practice at PwC and by analysts at Citi, shows that risks faced by companies have risen sharply due to the recession, increasing existing risks such as supply chain vulnerability, and adding new ones as firms adapt to survive. It also reveals that neither company management nor insurers have fully recognised changes to risk profiles, meaning insurance companies may be carrying unrecognised risks while firms’ cover may be inadequate, leaving investors exposed.

The report warns that: “Parallels can be drawn between large property & casualty insurance institutions today lacking the ability to fully understand changing risk exposures and more publicised past failures of financial institutions to understand risks assumed. While loss impacts naturally lag economic changes by several years, turmoil in commercial insurance is expected as a latter phase of the financial crisis.”

Key findings include:

  • The effect of the economic downturn has been to drastically raise the pace of change in the business world, way beyond headlines on failure rates and bailouts. The speed, number and significance of important granular changes across most companies’ day to day operations are unprecedented.
  • Such a severe recession has altered existing risks companies face and added new ones. Businesses are moving into less familiar activities, cutting costs and stretching themselves and their trading partners in order to cope with recession. For example, one high-tech manufacturer had doubled its rate of new-product launches in 2009 while cutting manufacturing lead times by 75% in a bid to cope with the downturn.
  • Management focus remains on putting new measures in place, with few yet understanding or communicating how risk is different. For example, the research found that 65% of companies do not review how their risk is explained to insurers as part of the contract on which their company relies. This puts insurance cover at risk and may leave shareholders bearing unexpected losses at a time when capital is scarce.
  • Insurance brokers and insurers have also so far failed to address these changes, suggesting systemic under-pricing of risk and a requirement for a potentially severe insurance market correction.

Bruce Hepburn, Chief Executive of Mactavish, said:

“Major business changes and great uncertainty around commercial risks have been caused by the recession, but nobody has really focused on this yet. This means that some companies are not properly insured, and insurers are carrying greater risks than they realise. Investors could end up bearing the cost of losses.

“The issue should not be underestimated. Companies are ultimately more reliant on insurance now given that few have the luxury of significant cash reserves and access to new debt remains limited.

British firms contain new risks that have not been properly understood or reflected. As a result of this combining with existing pressures on insurers, the insurance sector and the companies it serves could be facing a perfect storm that would form another phase of the financial crisis. Our research suggests that company managements, insurers and investors all need to wake up to face this reality.”

Achim Bauer, partner, PricewaterhouseCoopers, commenting on the Mactavish research says, “Many commercial insurers have failed to keep pace with the unprecedented changes in commercial risk and the findings have revealed significant flaws in the way commercial risk is assessed and insurance placed”.

“Insurers need to act quickly to identify areas of their portfolio where underwriting is most seriously misaligned, adjust reserves and explain the implications to their stakeholder community. Failure to do so will only exacerbate losses and further undermine market confidence.”

Citi’s investor note on the research warns of the risk to the property & casualty insurance sector. It says, “a sharp increase in commercial claims could be the ’straw that broke the camel’s back’ – driving a substantial shake-out, but with real differentiation between the insurers who are prepared and those who are not.”

“It is likely that the impact of the recession has yet to work its way through the system, with the potential for the changed risk environment to have much greater impact in 2010 and 2011. As such, we think this is an area that investors need to be on top of, as these trends could have a material impact on stock prices over the next 18 months, not only at a sector level, but also in differentiating between (…) insurers”


These findings clearly have potentially severe consequences for the insurance industry which underwrites the risks concerned. A significant focus of the study was therefore in testing insurer assessments of the changes observed, the level to which they are currently understood and their impact on insurer policy.

Key findings included:

  • Faced with sudden changes, the historic risk assessment models used by insurers become increasingly unreliable. Given the increase in risk, widespread under-pricing is inevitable through 2010 as underlying risk increases while rates suffer continued downward pressure.
  • An increased and more uncertain risk environment will impact claims costs, even if it can take years to become clear. It also raises the importance of existing weaknesses in the system used to explain and underwrite individual risks, leaving company shareholders and insurers exposed.
  • This introduces a new risk to earnings for Property & Casualty (P&C) insurers. Mactavish expects real variance in how exposed insurers are to this segment, and how well they are able to respond to the challenge of building closer customer relationships to better understand risks.
  • The insurance industry continues to fail to communicate its value to customers – with depressingly little buyer recognition of the value provided despite greater-than-ever dependence of companies on insurance capital.
  • This suggests that conditions are set for the type of extreme and localised volatility for which insurers have been harshly criticised in the past. The industry already works on very tight margins following fierce competition, and supported by an unusually benign claims environment recently. Recessionary risk impacts may break this cycle.

Mr Hepburn said: “The sheer level of business risk impact suggested by this research will become a huge issue for the insurance industry at a time when margins continue to shrink. Long-standing weaknesses in the system of understanding risk are increasingly exposed and history suggests some will rise to this challenge a lot better than others.”

Mr Bauer, PricewaterhouseCoopers, added: “This is a wake-up call to the insurance industry. Both insurers and insurance intermediaries need to fundamentally rethink how risk is assessed, how companies are insured and how to keep pace with an increasingly complex, uncertain and fast changing risk landscape. Taking action now will reduce the immediate business impact and strengthen their market position”

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