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Losses are big business for insurers.

In past columns I have questioned the insurance industry's claim that its success depends on improved risk management and lower loss levels. This column once again tackles this topic, as the war in the Persian Gulf has shed new light on a question I have asked before-Are insurers really interested in risk management?

At the start of the war, Lloyd's underwriter Ian Posgate was asked by the British newspaper Independent on Sunday how war would affect Lloyd's future. He said: "The worst that could happen would be a short, sharp war, and then peace. ... If the war lasts six months, or even a year ... they're bad underwriters if they don't make a profit."

A callously expressed opinion, but nevertheless true. The clash in the gulf has provided a bonanza of opportunity for war underwriters. Demand for insurance increased dramatically, giving insurers an opportunity to up their profits rapidly.

The basic product insurers provide is a claim payment when a loss occurs. Logically, the more losses industry suffers, the more insurance it demands and the more opportunity there is for insurers to prosper. Consider the many instances in recent years in which insurers have benefited from loss potentials, such as the rise of credit and political risk, liability risks for directors and officers and the risks involved in mergers and acquisitions.

What then do insurers mean when they say that loss reduction is in their best interests? Do they argue that no losses, and therefore no need for insurance, would be ideal? Does the logic behind this claim hold water?

No doubt, insurers are interested in risk predictability, which is not to be confused with risk reduction. Insurers will gladly cover large and small risks, provided that their frequency and severity can be predicted. It is of vital importance to insurers that they be able to match future claims obligations with present premium charges.

When Loss Control Is OK

Although some insurers insist on loss control measures as a prerequisite for insurance, it is not because they are interested in loss control per se. Rather, it is because loss control can make an unpredictable risk more predictable. Insurers may also encourage loss control when the price resistance may prevent them from getting the business at all.

What about specialist loss control insurers such as Factory Mutual? Unfortunately, insurers can derive no comfort from the answer: Factory Mutual was founded by insurance buyers who received no encouragement for their loss control efforts from their insurers.

Insurers get annoyed when told that their stake in risk reduction goes only as far as their public relations campaign. A Lloyd's marine underwriter rebutted that the Plimsoll line-a measurement developed in 1870 to indicate the maximum depth to which ships may be loaded-was introduced at the insistence of Lloyd's underwriters. That's not exactly a valiant attempt to reduce the level of risk.

In fact, insurance is incompatible with risk control. If 19th-century shipowners were so concerned about the risks they were running as to be prepared to accept the Plimsoll line to get insurance, what risk reduction measures might they have taken had there been no insurance available? The answer is obvious but nonetheless worth stating: The risks would have been reduced even more.

The fact that no insurance is the best form of risk control is understood by those familiar with the pollution coverage crisis. Insurers' withdrawal from the market for a risk that is too unpredictable (there's that word again) has done wonders for risk improvement. And the voluntary withdrawal from conventional insurance into some form of self-funding, as evidenced by the captive movement, also improved loss records.

The function of insurance is to make it easier for everyone to run risks. Hence, it should come as no surprise that insurance actually increases the level of risks and the likelihood of losses.

This would not be worth mentioning except that insurers tend to add risk management services to their range of products, leaving open the possible danger that risk managers will rely too heavily on organizations that make their money from losses. Chris F. Best is editor of Foresight, a London-based insurance and risk management journal published by Risk and Insurance Group Ltd.
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Author:Best, Chris F.
Publication:Risk Management
Date:Mar 1, 1991
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