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Even experts make mistakes.

Only in recent years have risk

managers come to feel at ease when talking to insurers and brokers about risk assessment, which is not surprising because insurers are supposed to be the experts in this area.

That is why one of their representatives recently described past efforts of risk managers to practice open market insurance through captives as the exercise of "innocent capacity." The captives weren't "real" insurers and could not know about risk assessment. They inevitably suffered severe losses from open market trading.

Much has happened since those not-so-distant times to dispel any illusions about the "exclusive" expertise of the professional insurance market. Perhaps nothing in the United Kingdom has so effectively cleared away these perceptions as the recent insights given to insurance buyers about the underwriting methods of a major British insurance company and of a famous Lloyd's underwriter.

First, Royal Insurance Group, which had a healthy solvency margin a few years ago, now has a reduced solvency margin of only 34 percent. The company's pretax loss by the end of the third quarter was about (British lb)2l4 million, compared to roughly E91 million in the same period during the previous year. The net loss was about E256 million, compared to roughly F86 million in the previous year. Anybody can have losses, but these are pretty bad-and what's worse is how they occurred.

Royal, as a professional insurer and an accredited risk assessment expert, is currently losing a disproportionate amount from the mortgage guarantee business. But property values in the United Kingdom have been falling steadily for years; this has been coupled with high interest rates, rising unemployment figures and curtailed wage increases for those who are still working. But Royal's risk assessment experts-its underwriters did not seem to notice any connection between these economic factors and the mortgage guarantee underwriting risks they were taking on; they cornered a 20 percent market share at rates which, now that claims are rising at an alarming rate, are suddenly being increased to 55 percent. Needless to say, new business is getting a sour response, tighter underwriting agreements are being sought and improved claims handling methods are being introduced. Professional "innocent capacity" is learning sophistication the hard way! T hen there is the current case in London in which a Lloyd's underwriter, Richard Outhwaite, is explaining how he, who inherited hundreds of years of Lloyd's underwriting tradition, approached the task of risk assessment some years ago when he was offered 31 run-off reinsurance contracts. These later resulted in heavy losses stemming from American asbestos and pollution-related claims. Lloyd's names on the 1982 year of Mr. Outhwaite's Syndicate 317 are suing 81 members' agents for damages due to alleged breaches of contract arising from the underwriter's alleged negligence in writing the contracts.

Daily reports of the Outhwaite case provide fascinating insight into the underwriting practice of "the professionals." So far, we have learned that Mr. Outhwaite, on his own admission, did not read asbestos reports available to him before underwriting the loss-making contracts, such as those held by Lloyd's Asbestos Working Party, nor did he read trade publications relating to American casualty insurance. Ulrich von Eicken, a reinsurer for 35 years who is a key expert witness for the plaintiffs, has been highly critical of Mr. Outhwaite's underwriting approach. He said that at the time Mr. Outhwaite took on the running-off contracts the market generally thought asbestos was a terrible problem of a magnitude unheard of before." Mr. Outhwaite and his cedents, however, contend that the claims that subsequently developed were completely unforeseeable. But, as known by historians, if not underwriters, the damaging effects of asbestos were familiar even in ancient Rome ! Mr. von Eicken strongly criticized Mr. Outhwaite for reinsuring accounts that were far removed from the potential source of claims (in other words, for acting as a retrocessionaire) because in such a relationship "you were too far removed from the risks to make any kind of meaningful assessment of outstanding losses and loss reserves." This might seem to risk managers as comparable to primary insurers who rely on their insureds' assessment of their own exposures.

Perhaps risk managers should use the "Outhwaite argument" when negotiating their renewals: Just rely on my estimate of my company's exposures, Mr. Underwriter. After all, that is the practice sanctioned by 300 years of tradition at Lloyd's."
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Title Annotation:London Perspective; insurance underwriting methods of Royal Insurance Group and Lloyd's of London
Author:Best, Chris F.
Publication:Risk Management
Article Type:Column
Date:Jan 1, 1992
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