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Ethics and risk management.

TODAY, THE CLIMATE for ethical conduct is increasingly volatile. The entire financial services industry has come under intense scrutiny on account of a confluence of forces. In the United States, the public's heightened concern about ethics in the securities, banking and insurance industries is threatening the essential asset of the financial services industry-America's confidence in our financial stability and security. Nationally, as well as globally, financial services are under siege:

A WALL STREET CONTINUES TO BE SHAKEN by various criminal allegations leading to trials and imprisonment.

A THE SAVINGS AND LOAN DEBACLE IS a virtual sinkhole, which will eventually cost American taxpayers an estimated $500 billion.

A MAJOR INSURER INSOLVENCIES, especially among life companies, have become headline news.

A BANK OF CREDIT AND COMMERCE INTERNATIONAL has been seized and senior bank officers located in several countries are being charged with running a racketeering enterprise.

A THE MANAGEMENT OF JAPAN's Full BANK and smaller institutions have been accused of fraudulent transactions involving billions of dollars.

Beyond the public scrutiny of financial services, ethical dilemmas are also arising across a broad spectrum of industries. For instance, physicians have come under attack for having financial interests in the labs that conduct their tests, and at least one ma or accounting firm has collapsed under the weight of lawsuits over gross professional negligence. Business and personal ethics are being further complicated by difficult economic conditions. Recessionary pressures are forcing many industries to cut expenses and downsize to compete. The threat of layoffs and other workplace pressures tend to relegate the issue of ethics to the periphery.

As once discrete professions fight for survival, distinguishing features among service businesses are blurring. The persistent soft market continues to test the insurance industry. Brokers and underwriters compete for a larger portion of market share, while buyers work to contain costs through lower premiums, higher retained risk and alternative markets.

In such an inhospitable economic climate, some believe sensitivity to ethical considerations is a luxury they can't afford. For those in risk management, this is a tragically myopic view. Qualitative considerations, such as professionalism and integrity, are now more than ever critical to the bottom line performance.

Situational Pressures

WHAT ARE THE FACTORS that reinforce ethical behavior? What are the factors that will undermine it? How should ethical standards be integrated into the risk management and brokerage professions? There is a situational nature to professional ethics. Within the risk management community, executives speak of continuing soft market competition which inexorably depresses prices. There is also a weak economy which pressures buyers to work with smaller budgets and to intensely pursue bargain deals. Brokers may find themselves in ethically awkward situations as they try to respond to buyers' demands. These real-world pressures underline the reality that the most difficult ethical dilemmas usually arise from daily transactions between individuals. They are not aberrations. In fact, these situations are often multifaceted and are far from abstract or theoretical.

Structural Challenges

BEYOND SOFT MARKET FORCES and fluctuations in business conditions, there are two structural reasons which help explain why the risk management and insurance industry is discussing ethics more frequently-and more seriously-than ever before.

First, there is the extraordinary complexity of risk management today. Twenty years ago, buyers, brokers and suppliers were essentially transferring risk from the insured to the insurer. Today, risk managers have tremendous flexibility in dealing with their exposures. Their options include captives, sophisticated loss-control programs, and self-insurance, among other financial situations.

The second reason for an increase in ethical gray areas between brokers and buyers is the "verticalization" of the brokerage industry. Brokers are no longer simply arranging traditional insurance coverages. As national and global corporations, many broking now offer a diverse range of consulting, broker and financial services to meet clients' risk management needs.

These structural changes have produced more complicated transactional relationships involving an array of insurance products and services. Some say this has resulted in various temptations to take short cuts-to play games.

Ethical Conduct

IN COPING WITH this difficult risk management environment, many executives embrace what might be called a common sense approach. They contend that ethical problems do not occur in a vacuum. These problems emerge from the interactions between two or more players; these executives note that "it takes (at least) two to tango. " Lofty principles and pontification do little to make people more ethical. Scrupulous conduct comes from one's personal value system. in effect, there exists a dual nature of ethical dilemmas. External pressures, such as cyclical business conditions, help create or complicate ethical problems. These pressures tempt those caught in the throes of a weak economy to rationalize and dispel ethical considerations and to focus solely on the bottom line. But, despite such pressures, it is ultimately the internal, dynamic, individual choice, which dictates the response.

Although the resolution of ethical problems depends on the individual's judgment, ethical conduct can be encouraged and refined. The CPCU journal polled members on the external and internal components of ethical conduct. Respondents rated situations which can create challenges to ethical conduct. The evidence suggests that the leading threats to ethical conduct are partially the result of outside factors, such as a recessionary economy. However, the consensus was that most people ultimately rely on their own beliefs when facing ethical dilemmas. In general, ethical behavior is best sustained by avoiding inherently problematic situations and by promoting greater ethical self-awareness.

Most business people find themselves in difficult ethical situations at sometime during their careers. What resources will help us make the right decisions? One of the best ways to foster greater awareness is to stimulate conversations at every level on how to arrive at ethical judgments. Another approach is to use professional meetings as forums to dramatize relevant issues and to help develop skills in analyzing real-world problems.

Encouraging public dialogue within the business community is important because in the services business, a company's most precious capital is its employees. Their integrity and professionalism determine the company's image and its ultimate success in the marketplace. In addition, as business sectors consolidate through shake-outs and mergers, the propriety of business conduct will be a critical distinction among the survivors. The fact is, ethics will increasingly be a strategic business consideration.

Impediments To Ethical Conduct

ALEXANDER & ALEXANDER'S Government and Industry Affairs office recently polled executives in the risk management community on the tendencies causing ethical problems among buyers, brokers, and underwriters. How can the risk manager stay out of trouble? First, there must be an awareness about certain types of situations which are intrinsically troublesome. For example, don't commit to coverage from a broker who offers a broadly sketched proposal with a low, "ball park" quote. An exceptionally low quote should raise questions about the offered coverage. There are no free lunches, especially in the current market. Second, make and insist on full disclosure. Your best protection against surprises is to ut all your cards face up on the table, and require the other party to do the same.

Unfortunately, too many people subscribe to the adage, "If they don't ask, I don't tell 'em." When it comes to representing exposures and explaining coverage, this is a disastrous prescription. As a result, some of the client's exposures may not be adequately insured. This lack of communication also jeopardizes the insurer/broker relationship.

Certain business practices among underwriters may also undermine ethical behavior such as indiscriminate managing general agent authorization. Since insurers usually authorize managing general agents to underwrite policies, the insurers may sometimes be bound to risks which they would not normally have assumed. In addition, managing general agents who are eager for market share may offer policy premium rates which are too low to cover the actual losses.

Bad Practices

ANOTHER PRACTICE with the potential for unethical behavior is leveraging lines of business ("tie-ins") by underwriters, particularly providing coverage for one type of risk for access to write other lines. In addition, this may close markets to small and mid-sized brokers because of their relatively low volume.

In this survey, risk managers identified practices by insurers and brokers that caused ethical difficulty such as undisclosed broker's commission on top of a "fees for service" contract and "market blocking" by brokers to prevent competitors from obtaining quotes on a piece of business. From the brokers' perspective, certain risk management practices were criticized. Brokers complained about risk managers who claimed that competition for bids was open when, in fact, a broker had already been chosen. Sometimes this tactic is used to allow the chosen broker to review proposals by competing brokers and, thereby, obtain ideas on placing coverage. They also criticized risk managers who demanded unnecessarily complicated proposals to discourage some brokers from bidding, which limits competition and undercuts smaller brokerage firms. Other ethical problems may be caused by insisting that coverage be driven by low cost rather than quality. Buyers driven only by financial considerations may discover that they are not adequately covered.

Another problem is asking for a share of the commission, or a "finder's fee," after the deal had gone through, when the commission was not part of the original agreement. Also, there are risk managers who abuse brokers' hospitality by linking entertainment favors to "maintaining the relationship."

Reinforcing Ethics

IN SOME OF THESE problem areas, there may be honest disagreements about the line between justifiably competitive practices and unethical behavior. Nevertheless, identifying the problem sheds light on potentially gray areas. It is also essential to recognize that proper conduct can be effectively encouraged through ongoing discussions with one's peers. For instance, developing and reinforcing an inhouse process for addressing germane issues is far more valuable than memorizing an ethical code. These discussions need to occur in three contexts: among buyers, brokers, and underwriters in their individual companies, at professional meetings and in public forums, such as trade and business publications.

These dialogues are most useful when they focus candidly on the specific situations which give rise to ethical dilemmas. The growing complexity of risk management will not make the task any easier. But, it is imperative to continue to strive for the highest professional standards and foster greater industry awareness of the most valued aspects of professional behavior. This could ultimately become the basis for a thoughtful, real- world development of an ethical code.

On the Horizon

IN THE 1990S, various factors could complicate our ability to deal with professional ethics. The most challenging near-term development is likely to be in federal regulation. Further, major insolvencies or a sudden and severe turn in the commercial market could trigger federal intervention. Precipitous federal involvement in the insurance business could usher in volatile and unpredictable consequences.

Given the industry's poor public image, intervention could be quite punitive. A punitive federal presence could make the industry wish it had more seriously addressed ethical problems a decade earlier. On the horizon, there is a complex socio-economic trend which will pose difficult ethical challenges. This emerging issue is the diversification of America's work force. in this decade, the American workplace will be characterized by an accelerating diversity of ethnic backgrounds, religions and cultural attitudes. This will pose a daunting challenge to management.

Throughout most of this century, white males dominated the U.S. labor force. However, the situation changed drastically in the last decade. Current estimates are that only 15 percent of new entrants to the labor force in the 1990s will be white males. Additionally, the increasing flow of global workers will add yet another dynamic to the mix. In this environment, it will be critical for techniques to evolve that encourage a multicultural work force to develop and adhere to a uniform set of business practices. These practices should be based on qualitative considerations such as shared standards of ethical conduct.

These are just some of the challenges for the future. Despite our difficulties, the risk management community does have the capacity to confront its professional and business challenges. if we have the will to deal honestly and innovatively with our problems, we can successfully manage our way through them. But, we can only do this by working togetherwith our peers in both the public and private sectors.
COPYRIGHT 1992 Risk Management Society Publishing, Inc.
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1992 Gale, Cengage Learning. All rights reserved.

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Author:Moore, Robert H.
Publication:Risk Management
Date:Mar 1, 1992
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