Information & insurance: the power of transparency; Now, even relatively small companies can access the data and analytical tools necessary to make better risk-retention, risk-transfer and risk-financing decisions.

Insurance is fundamentally a simple product with a clear purpose--to make individuals and businesses whole following certain types of economic loss. However, for today's financial executives, the processes of pricing risk and of buying property and casualty insurance can be, as Winston Churchill once said of Russia, "a riddle wrapped in a mystery inside an enigma."

For larger firms, insurance can be a multi-million-dollar expenditure. Mistakes in the type and amount of insurance purchased, or in the choice of an insurance company, have potentially devastating consequences. Yet, commercial insurance buyers frequently do not have access to the information necessary to make informed buying decisions.

A recent survey of buyers of commercial insurance by Advisen Ltd. found that 74 percent of the nearly 700 respondents want a standardized and transparent insurance transaction process, and 67 percent want better information on the prices and terms being transacted in the insurance marketplace. The survey profiled insurance buyers' opinions on the impact of New York Attorney General Eliot Spitzer's recent suit against alleged bid-rigging and other anti-competitive practices. Written comments from respondents made it clear that many buyers intend to increase direct communication with underwriters and be more involved in evaluating quotes.

But much of the information needed to fully assess and price risk is locked away in the policy and claims statistics amassed by insurers, who have little incentive to share this information with their customers. Brokers can supply market knowledge and risk expertise, but they also may suffer from information gaps. And, as has recently come to light in Spitzer's probe of the insurance industry, the incentives of some brokers have not always been aligned with the best interests of their clients.

Fortunately for commercial insurance buyers, digitized data and the technologies to rapidly transmit, compile and analyze those data have simplified the processes of assessing, managing and financing risk. Buyers can tap into databases of risk-related information to help quantify and price exposures.

A new generation of online tools can assist in analyzing risk-financing alternatives, and can benchmark insurance program structures and pricing against a company's peer group based on near-real-time market information. For the first time, even comparatively small companies have access to the data and the analytical tools necessary to make better risk-retention, risk-transfer and risk-financing decisions.

Insurance protects the bottom line, and the bottom line is the right place to begin evaluating risk management goals and the means of achieving them. Companies need to determine how much risk they can afford to take, and structure their insurance programs with an eye towards not only transferring risk, but also towards prudently retaining risk. Too often, companies pay brokers and insurers up to 50 percent over the actual claims costs for the privilege of paying claims well within the company's financial capacity to handle.

But there are times when it makes sense to transfer more risk to insurers, and that time may be approaching quickly. On average, commercial insurance premiums have declined in every quarter of 2004. At some point in the near future, competition may drive premiums near to, or even below, claims costs. Market information such as the RIMS Cost of Risk Survey[TM] and the Advisen Premium Index (ADVx[TM]) allows insurance buyers to track rising and falling commercial premium levels, enabling them to make better-informed decisions about when it is financially advantageous to retain risk, and when it is preferable to transfer it to insurers.

Current market data also permits buyers to take a snapshot of market conditions and benchmark their own insurance program against their peers. Using online benchmarking tools, insurance buyers can define a peer group based on various demographic criteria, and see how their program compares to that peer group in terms of the amount of insurance purchased, the amount of risk retained and the premiums paid for the coverage. Recent allegations that some brokers steered business to insurers offering the best commissions to the broker, but not necessarily the best terms for the buyer, underscores the importance for buyers to understand how their insurance programs stack up in the market.

D & O Market Volatility Continues

Pricing transparency and robust risk assessment data are desirable for buyers of every type of insurance coverage, but are particularly critical for making informed decisions about directors and officers (D & O) liability insurance. The D & O liability insurance market is among the most volatile. Excess capacity drove rates down throughout much of the 1990s. Inadequate pricing, coupled with skyrocketing securities class action settlements, eventually forced many insurers to leave the market or limit the types of business they would insure.

When commercial insurance rates began to rise in 2001, D & O rates soared. Only within the third quarter of 2004 have rates stabilized on average. These wide pricing swings have frustrated D & O insurance buyers, who often struggle to understand the rationale behind the pricing of their policies.

Assessing and pricing D & O risk is a complex and imprecise process for even the most experienced underwriter. But, here too, new data sources and risk assessment tools streamline the process and improve pricing precision. These same resources are available to buyers, equipping them to better manage their D & O exposures, to determine how their exposures compare to other similar companies and to negotiate with underwriters based on objective and verifiable risk criteria.

D & O risk assessment resources available to both underwriters and insurance buyers include such things as corporate governance scoring systems and accrual accounting metrics that tie accounting practices to the probability of being the target of a securities class action suit.

While buyers don't have access to insurer claims files--such as those used by actuaries to price risk--they do have access to detailed information on securities class action suits, the principal cause of claims under public company D & O policies. These resources alone can provide D & O insurance buyers with new insights into their exposures and the ability to estimate the relative likelihood of their company experiencing a D & O claim. Armed with this information, they can take steps to improve their risk profile, make better-informed decisions about risk retention and conduct more successful negotiations concerning risk financing or risk transfer.

Although just publicly launched last April, Spitzer's probe into the insurance industry already is reshaping the ways in which commercial insurance is transacted. New regulations are being introduced, mandating greater disclosure of broker compensation. Large brokers and insurers have ended the use of contingent commission agreements--the supplemental compensation plans at the core of Spitzer's investigation. But some of the most significant and lasting changes may not be driven by litigation or regulation, but by market forces.

Commercial insurance buyers, angered by allegations of anti-competitive and fraudulent activities--and seizing the opportunity created by the bright spotlight now illuminating the insurance transaction process--are demanding substantive changes.

Written comments from participants in Advisen's risk manager survey make it clear that buyers are demanding more information, greater accountability and the opportunity to be involved in decisions at each step of the insurance placement process. Indeed, buyers have been disadvantaged by not having the information and the tools to evaluate and price their own risks. That will soon be history as rapidly changing new sources of risk information and powerful tools to convert that information into actionable knowledge become available to buyers.

David K. Bradford is Executive Vice President of Advisen Ltd, an information services firm for the commercial insurance sector based in New York. He can be reached at [e-mail].