What data should be included in the review?
Nelson: Companies should use sophisticated data modeling techniques and software to predict future claims by analyzing prior losses. The review may expose savings opportunities through the strategic acquisition of additional risk or reduction in the frequency or severity of claims through loss control or safety measures. In the world of property insurance, historical analysis has given way to predictive modeling that includes a real-time view of major events such as brush fires or windstorms and forecasts the probability of such events within a relative range of certainty. The model shows how these events have historically played out, which helps companies develop contingency and mitigation plans to avoid business interruption and sustained revenue losses.
Petrides: Sophisticated organizations have been collecting data for long periods of time and, based on the credibility of that information, can parameterize models using analyses of this data. Whatever metrics you use, it’s important to model the cost of capital and the equity costs associated with changing retention levels before you decide on a risk financing strategy. Insurance should be viewed as contingent capital rather than an expense. Additionally, the domino-like financial ramifications associated with a major event, like lower credit ratings, increased debt obligations and client defections should be considered in the modeling exercise. Overlay different variables to estimate the financial impact of each scenario before finalizing a risk statement and financing strategy.
How can companies optimize insurance purchases through data?
Nelson: Whether the insurance market is soft or hard, leverage your negotiating power by determining your risk tolerance up front, surveying the marketplace and dictating your retention levels before you enter the market. If you find a deal, it may make sense to purchase additional coverage and reduce your risk, but conversely, a company should never take on more risk than it can withstand.
Petrides: Companies can use predictive models or more sophisticated models to help negotiate higher coverage limits and pricing concessions when they enter the market. The data and analyses may establish your company as a premium risk, which will open the door to additional markets or justify higher retention levels.
Which alternate financing strategies are worth considering?
Petrides: Flexing your model or using a blended approach can be advantageous when dealing with a volatile market. There’s nothing wrong with purchasing additional insurance today, if it offers greater financial security, and returning to higher retentions when the market hardens.
Nelson: The tax benefits associated with captives, such as accelerated deductions for losses, have made them very attractive. But we’re also seeing some industries utilize captives to get into the risk management business and turn it into a profit-making venture. Offering buyers extended warranties is one example, another is offering renters of self-storage units property insurance. Not only does it allow the risk taker to make a profit, it may curtail claims, in the event customers search for a deep pocket to cover uninsured losses. The options and models are almost limitless, but a successful risk strategy always begins with a well-defined risk statement.
Craig Nelson is a senior consultant for Risk Advisory and Brokerage Services at Towers Watson. Reach him at (303) 628-4026 or [email protected]. Anne Petrides, FCAS, MAAA, is a senior consultant and actuary for Risk Advisory and Brokerage Services at Towers Watson. Reach her at (415) 836-1109 or [email protected].