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One size does not fit all when it comes to insurance or calling time on commoditised insurance for all risks

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The views expressed in this article are not necessarily those of the FIA. The article below was supplied by AIG.

Certain risks are too large or too complex for the one-size-fits-all approach of commoditised insurance

The last decade has seen a steady trend towards the commoditisation of insurance, with price as one of the main differentiators. This trend has largely been driven by technology, which has given underwriters powerful tools to build robust risk profiles. The result has been a shift in the role of insurers, who are now often regarded as providers of capacity.

Insurance as a commodity works well for personal lines, where high volumes and low premiums are the order of the day. The risks are well understood and fall into clear patterns, and, in the main, individual pay-outs are generally not large. All the products can thus offer broad coverage.

Over time, however, this approach has become more common across the whole industry. The long-term softness of the insurance market has also played a part in encouraging insurers to compete for all business predominantly on price, sometimes at the expense of being able to build long-term partnerships with clients.

In areas where risks are complex or just very large, this is far from satisfactory, both for the insurer and for the client. Such areas would include commercial property, aviation and marine insurance. The risks in each are impacted by a complex set of variables, and each specific risk has its own unique profile that is highly dependent on circumstance. Claims pay-outs can also be very large.

Such risks are much less suited to the one-size-fits-all approach of commoditised insurance.

From the insurers’ point of view, commoditisation does not work for complex risks because they don’t get the opportunity to understand the nuances of the client’s business and the risks they are insuring. In the end, loss trends inevitably start to pick up as unforeseen or uncovered risks materialise, and insurers will begin to reduce their exposure to the sector, thus reducing capacity, and/or raise premiums. This is starting to occur, and we expect this to develop into a trend over the next 18 months or so.

Insurance commoditisation also has a downside for clients. When clients see insurance simply as something they buy, they in fact lose a valuable opportunity to deepen their understanding of the risks that their business faces, and how to reduce them. Companies tend to have close relationships with their brokers already, but think what could be achieved if the insurer was part of this.

In this regard, the emphasis that the King Code of Corporate Governance places on risk management is relevant. Principle 11 of King IV, for example, says: “The governing body should govern risk in a way that supports the organisation in setting and achieving its strategic objectives.” Such thinking is clearly based on the realisation that corporate sustainability and risk management are inseparable.

In other words, if a valuable cargo is ruined, an insurance pay-out is better than none, but the impact of the loss on the business in terms of reputational damage, damaged client relationships and possible legal action could be much bigger and long-lasting. A deep relationship of trust with an insurer, whose core business is understanding and mitigating risk, is a valuable asset in a risky and highly competitive world.

Commodity-like insurance remains useful in areas where premiums are low and volumes are high. But when the risks are larger and/ or specialised, then the best option is to build a close relationship between broker, insurer and client.