Tag Archives: risk control

Moving to Real-Time Risk Management

In insurance, sales are usually periodic, but risks are continuous. In personal lines, for example, annual or semiannual automobile renewals are automated, and a customer may not speak with an agent or a representative of an insurer for an extended period. Insureds do not receive continual rick consultation, because it is high-touch and high-cost, and can unintentionally retain risks. This is especially true during times of change. New activities, conditions or locations often increase exposure.

This post explores how technology can be combined with a customized service proposition to deliver continuous, real-time risk management. In the process, digital technology can reshape patterns of engagement between insurers and their customers that have existed for decades (or centuries).

Look at what happens every day as teenagers become drivers. As learners, their skill level is low. As drivers, they make poor decisions and crash more often. Parents try to supplement the teaching of driving schools but with mixed results. High loss frequency and severity for the 16- to 20-year-old age group, particularly males, drives insurance premiums to unaffordable levels. More significantly, many people are injured or are killed in accidents involving youthful drivers.

Now look at the approach taken by Ingenie, an insurance broker founded in the UK in 2010. The founders observed the safety and affordability issues in the UK motor market and set out to design a proposition to address both issues. At that time, telematics solutions were just beginning to take shape. However, Ingenie intended to go beyond a simple black-box-in-a-car approach. It partnered with the Williams Formula 1 team and used its racing experience and data to build sophisticated algorithms that analyzed driving patterns and predicted the behaviors that were most likely to result in an accident. Ingenie also engaged psychologists at Cranfield University to understand the specific emotional and physical characteristics of youths. With insights from these sources, Ingenie built an engagement approach focused on this age group.

Ingenie’s founders were veterans of the insurance software industry and had the technological skills to build a platform that blended social media, call center technology and an online app. The objective was to provide real-time feedback to influence driving behavior by communicating at appropriate intervals and in the most effective manner. As the telematics device in the vehicle reported the driving details, if the data showed that a young driver was performing better (safer) than her peers, she received a discount on her insurance. If the driving was not as safe as it could be, the driver received a text outlining what driving behavior could be improved, with a link to training videos and other multimedia sources. If the actions were severe, the driver was contacted directly by a call center employee of Ingenie. The company employs psychology majors from local universities, usually young men and women in their early 20s, in the service centers to counsel the youths and to speak to them on their own terms.

The model is proving successful. Between 2012 and 2013, behaviors improved such that average premiums dropped 23% for 17-year-olds and 10% for those who were 18. The broker has earned rapid growth in the UK market — 2013 premiums were more than $80 million. In 2014, Ingenie expanded into Canada.

By going beyond pure telematics, Ingenie delivers continuing risk control that previously had not been possible or affordable. Going forward, digital technologies will continue to provide similar opportunities across other lines of business – increasing both the efficiency and effectiveness of risk management.

ERM: Everything Risk Management

References to enterprise risk management (ERM) pervade insurance discussions of late. Driven by impending regulatory reform in the U.S. and UK, the investment-related aspects of ERM were amplified in the aftermath of the financial crisis, as insurers dealt with impairment and other-than-temporary-impairment (OTTI) issues in their portfolio, while at the same time operating in a market with soft pricing for many underwriting lines. Efforts to take a holistic approach in managing enterprise-wide risk can present various challenges in integrating the potentially vast flows of information.

The classic Peter Drucker axiom “what gets measured, gets managed” still rings true, but determining which are the key metrics as one embarks on the ERM journey can prove daunting. ERM feels like “everything risk management” and frequently, it seems, the investment portfolio is not fully counted in the calculus. Five years on from the peak of the financial crisis, memories are fading of how financial market turmoil can ravage an insurer’s investment portfolio and thus impact its entire business model.

From an investment perspective, preparing an investment portfolio for a rising interest rate climate is a critical component of the ERM complex. Rising interest rates pose a challenge to an insurer’s capital by diminishing principal value on a market-to-market basis. Insurers are often less concerned about positioning their portfolio for rising rates than they should be, particularly if their organisation has historically employed a book yield, buy-and-hold mentality that involves infrequent selling of bonds prior to maturity.

With an ERM framework in mind, let’s briefly examine three risks that all have a bearing on an insurer’s capital growth and preservation, and what they portend in a rising interest rate environment.

Investment Risk No. 1: Complacency, or a static approach to managing assets

A static approach to managing a bond portfolio is most problematic if rates rise very quickly. A portfolio which is not repositioned proactively as market dynamics change simply reinvests at the mercy of prevailing rates when bonds mature. Reinvestment of coupon income and maturing bonds may pose little trouble if rates are rising, however if the bonds must be sold prior to maturity, an insurer may not realize the price reflected in the carrying value.

A quick review of bond issuance over the past few years shows a universe in which credit quality has decidedly migrated downward. In fact over 50% of the corporate bond market is BBB or below (the BBB-category is the lower bound for investment grade, below is considered high yield or ‘junk’), according to Barclays and Securities Industry and Financial Markets Association (SIFMA) data. Additionally, the maturities of debt issues have extended. The average maturity of a corporate bond was nearly 14 years in 2012. Ten years earlier, average maturity stood at eight years. It makes sense, after all – what corporation’s CFO would not want to borrow for as long a timeframe as possible given the historic lows of today’s interest rates? An insurer that seeks to replace the yield of maturing bonds in today’s environment may, somewhat unwittingly, extend itself both in terms of lesser credit quality and longer maturity. Neither are good for protecting capital when rates begin to rise.

At Sage, even when we manage a core bond portfolio with book yield constraints we monitor issues of portfolio duration and credit quality rigorously. There is no semi-aware “drift” into lesser or longer credits in the pursuit of absolute yield. As an extension of our captive clients’ risk management function, we seek to imbue the investment process with the same risk-awareness as the rest of the insurer’s operations.

A static approach with the surplus portfolio can also challenge capital. Frequently, when insurers seek additional capital growth and return in non-core asset classes such as preferred stocks, high yield bonds, or segments of the equity market, the same buy-and-hold approach prevails. We are firmly of the belief that a more active and tactical approach to managing surplus investments is just as important to investment risk management as it is in the core bond portfolio. Rarely will a constant allocation to yield-seeking segments bear out an optimised risk/return profile for the insurer, as the next point demonstrates.

Investment Risk No. 2 Asset allocation

It must be firmly acknowledged that the business goals and operating cashflow needs of a captive or risk retention group (RRG) are the primary driver of asset allocation. After all, an insurer cannot set asset allocation in a vacuum. There is no “standard” portfolio irrespective of the insurer’s underwriting book or corporate structure. A quickly growing RRG may seek to protect surplus to the utmost and carry no equity exposure. A single-parent captive with a parental liquidity backstop may invest 60% or more of the portfolio in equities and alternatives with a goal of growing capital more quickly. An 831(b) captive may invest in more tax exempt instruments in an effort to minimise the lone taxable element (investment income) of the captive.

A bunker mentality does not benefit a captive’s portfolio. Our perspective is simply that the portfolio must be constructed in a fashion that supports the captive’s liabilities and parental objectives, with securities that enable a transparent and efficient means of providing both return and liquidity, while always seeking to protect downside volatility. Just like a static approach to investing the captive’s portfolio can be detrimental, so too can an overly narrow universe of investment options, such as limiting a portfolio to only a few types of instruments. In 2012, the range of returns on fixed income segments was actually greater at 16.18% (from emerging  market debt with 17.95% return vs. international government bonds at 1.77%) than was the differential between the top-performing segment in the equities/alternatives space when compared to the bottom segment.

In the past, we have discussed the merits that exchange traded funds (ETFs) offer to insurers of all types in crafting exposure to equities or alternatives such as bank loans, emerging market corporate debt or sovereign debt. For de novo captives (generally single parent, depending on domicile guidelines) there are NAIC-rated fixed income ETFs covering every major bond market segment that allow for a diversified, high grade portfolio from inception. We have managed tactical ETF portfolios alongside core bond portfolios for over 15 years, and ETFs are one area where insurers experience continued improvement in cost and efficiencies in their portfolio.

An insurer is the ultimate arbiter of what is appropriate for their portfolio. At the business-as-usual end of the continuum, protecting capital erosion preserves competitive flexibility and operating margin; under the most severe of market conditions, protecting capital precludes the need for a liquidity injection from the corporate parent or capital calls to group or RRG members.

Investment Risk No. 3 Confusing capital quality with liquidity

Capital quality (i.e. the credit rating of a bond) and liquidity should not be confused. A captive insurer seeking to sell 25 bonds of a well-known ‘AA’ rated corporate issue may find a much better bid side than does an insurer seeking to sell an identical amount of bonds for an ‘AA’ rated, but thinly traded municipal issue.

Likewise, even a high grade bond portfolio which has extended its duration in an effort to maintain or seek out additional yield will have a different liquidity profile when interest rates begin to rise. The integration of various risks (business, operational, investment) is at the core of ERM framework. If a variety of challenges bear down on an insurer all at once, for instance if a natural disaster which triggers claims payments coincides with falling bond prices, a captive should have a sound understanding of the liquidity profile of its investments. Beyond the core bond portfolio, a captive who holds a portfolio of individual equities may find their ability to quickly raise cash limited under certain market conditions. Given the smaller average size of a captive portfolio, the lots tend to be smaller and therefore have a more limited bid side. And apart from pure liquidity concerns, the frictional costs of moving into or out of individual equity positions can chip away at the captive’s capital.

The challenge with distinguishing between capital quality and liquidity is that it doesn’t matter until it matters.

Conclusion

Captives in the US and Europe may avoid the requirements of solvency self-assessment due to minimum premium thresholds under the NAIC and EIOPA frameworks for ORSA. Nonetheless, for ERM purposes, the foregoing considerations will help captives and RRGs manage investment risk, particularly in the face of rising interest rates. Proper planning with the portfolio will enable improvisation on the business side if needed. 

This article first appeared in Captive Review Magazine.

4 Keys to Competitiveness in the New Economy

This post is the first of a four-part series.

Ask any business owner today how the marketplace has treated them the last few years, and you’ll hear a recurring theme: “It’s been hard.” But some have learned how to improve their risk management and shore up several facets of their business where profit leaks can occur. You can explore your own vulnerabilities to claims and correct them by following a system known as “PX4.”

The 4 P’s are:

1. Pre-Hire : What does your hiring process look like?

2. Post-Offer: What should you be doing after you’ve offered someone a job?

3. Pre-Claim: What policies and procedures do you have in place before you have your next loss (whether via workers’ compensation or something else)?

4. Post-Claim: What systems do you have in place to keep yourself and the insurance carriers from losing money because of things you let fall through the cracks?

We’ll cover the first P in this article, then discuss each of the other three in subsequent pieces, as we cover the concept of TCOR (Total Cost of Risk) and lay out tools you can use to streamline and organize various aspects of your business, such as training and claims management. Our goal is for you to take away several insights that could save your company hundreds of thousands of dollars or maybe even millions of dollars in lost profits and revenues.

Pre-Hire

If you’ve had to deal with an employee lawsuit in the past few years, you know they’re frustrating and lead to a major loss of profits. Lawsuits can come from many issues; for this series, we’ll cover lawsuits coming from EEOC issues or workers’ compensation claims.

In the last 10 years, the settlement costs of lawsuits have risen to more than $310,000. If you were sued by one of your employees, and the settlement was a mere $15,000, how much do you think that would cost your company? Would you be surprised to learn a claim like that would cost your company more than $50,000? If your profit margins were 4%, it would take you $1,250,000 in additional sales to make up for that loss.

Reducing your risk is critical to your bottom line. Business risk can take many forms, such as:

1. Financial Risk: Asset price volatility (currency, interest rates, material and labor costs)

2. Operational Risk: Efficiency, productivity, etc.

3. Hazard Risk: Lawsuits, insurance claims (workers’ comp, general liability, fire, etc.)

Of those three areas, companies are surprised to learn that operational risk is the costliest to companies. Although hazard risks are expensive, they can be transferred through the purchase of insurance policies.

To reduce your risk, you must begin with an assessment of your hiring practices. Do you feel like you have a watertight system in place, or have you gotten rusty because you’ve not been doing a lot of hiring in the past several years? Do you feel you’re using good employment applications and asking appropriate questions?

What successful companies realize is that the effectiveness of their hiring can be a great indicator for profitability in the future. Studies have shown that hiring the wrong person can be very costly, and not only from the loss of productivity or from having to find a replacement; bad hires can be fertile ground for workers’ compensation claims.

To avoid bad hires, it is always wise to request a Motor Vehicle Report on potential hires from a vendor who specializes in that service. A couple of good sources are the Insurance Information Exchange (www.iix.com) or LexisNexis Employment Screening (www.screennow.com).

You may also want to consider conducting a personality profile to make sure you don’t hire the proverbial “dog that can point but that can’t hunt”—someone who can tell you exactly what you want to hear but who isn’t a good fit for your company. Predictive Results (www.predictiveresults.com) and Zero Risk HR (www.zeroriskhr.com) are two companies that specialize in personality profiles; they claim a 96% success rate in helping you make sure you’re hiring the best person.

Back ground checks have become a routine part of the pre-hire process these days. You can contact First Advantage (www.FADV.com), Edge Information Management (www.edgeinformation.com) or National Crime Search (www.nationalcrimesearch.com ) for this important process.

Getting the Pre-Hire process right will get you moving in the right direction but is just the start. In our next post, we’ll look at the second part of the “PX4” plan – The Post –Offer process. 

Copper Theft Solution Reduces Claims For Construction Sites

Copper theft presents a significant challenge for loss control.

Unlike other property crimes where “recovery” goes a long way toward mitigating the loss, such as the recovery of a stolen car in an auto theft, the recovery of the stolen copper seldom impacts the size of the claim.

Copper theft is different because the damage done to a building stealing a few hundred dollars' worth of copper can cost insurers tens of thousands of dollars to repair. The typical copper theft claim involves the damage done ripping wires and plumbing out of walls or the coils from a rooftop HVAC system. In vacant buildings, thieves target water lines and sprinkler systems as well as the electrical wiring. Once a vacant property has been hit, thousands of dollars must be spent to bring it back up to code before it can be occupied. It is this “collateral damage” that makes copper theft claims so expensive to an insurance company.

The key to reducing copper theft claims is prompt police response. The faster law enforcement arrives, the less time thieves have to damage the property. Faster police response is what wireless video alarms deliver and why they are a valuable tool for loss control against copper theft.

Copper theft has impacted insurance companies across North America, becoming a mainstream problem covered by television news. The following reports from television news underscore much of what this article is attempting to communicate — a new paradigm to mitigate risk and reduce claims impacting the real world from Virginia to Arizona.

Construction crime is a close cousin to copper theft and has been a black hole for risk management with few affordable solutions. The nature of construction risk is temporary and this means that wired surveillance cameras and alarm systems are simply too expensive and cumbersome to install to make them cost-effective.

The technology challenges are significant: in addition to limited budgets there is often no power, no phone lines, and no easy access to internet. Policy holders do not want to spend large amounts of money for temporary infrastructure that has no value after the job is done. For construction, human guarding is the most obvious approach, but it is beyond the budgets of many job sites. With guarding cost prohibitive, from a loss control perspective there have been very few affordable options for mainstream policy holders to protect their projects. Construction remains a problem child for many insurers who are forced to raise deductibles and implement exclusions to make construction profitable.

The following newscast from Buffalo, New York describes the challenges of securing a construction site and successes found with wireless video alarm systems.

While human guards have become too expensive and unreliable for many sites, technology is improving and loss control has a new tool to secure construction sites. Portable wireless video alarms give loss control professionals an affordable tool to deliver police response to a job site before the damage occurs. These new wireless camera/detectors (called MotionViewers) sense an intruder and send a short video clip of the incident over the cell network to a central monitoring station for immediate review and police dispatch and priority police response.

The immediate review/response with a monitored video alarm has proven more effective than human guards as the sensor/cameras are installed in multiple points across the job site to detect and report any activity. The crucial factor in reducing claims for copper theft is immediate police response, and video verified alarms make all the difference — the monitoring central station operator is a virtual eyewitness to the crime.

Police treat a video verified alarm as a crime-in-progress — they respond faster and they make arrests. Case studies on video verified alarms have arrest rates of over 50%. One construction site in Arizona had 40 arrests over four months on a single site. Arrests make a difference because one arrest prevents an additional 30 crimes — copper theft is typically done by habitual thieves who target construction sites or vacant property.

To be affordable and effective, the camera/sensors must be easy to install, without the cost of trenching cables and running wires. Power is a challenge as many construction sites have only temporary power provided by generators during working hours. Many vacant building have no power at all.

The wireless Videofied alarm systems need no infrastructure to secure a site. They operate for months or even years on batteries, communicating over the cell network to the central station. These portable MotionViewers are more effective than fixed cameras because they can be moved to protect the assets on a job site as the project evolves. Portability is important because construction theft is often an inside job by a subcontractor familiar with the delivery and location of expensive materials or assets — and they know the locations of fixed cameras and how to avoid them. In contrast, magnetic mounts on the wireless MotionViewers enable the job supervisor to move the cameras, placing them on steel studs and tool cribs at the end of the day to protect what is most at risk.

Wireless video verified alarms for outdoor applications mean that loss control professionals have an effective tool to fight copper theft that is affordable enough for implementation by their policy holders. For more information visit www.videofied.com.

Leap Year: Season 2, Episode 4 – Just Trying To Survive


Leap Year Season 2: Episode 4 by Mashable

Dumpster diving? Exploding flour robots? Eccentric and confusing investors? These aren’t things all startups have to deal with, right? It’s starting to feel like the C3D crew is really scraping the bottom of the barrel, or dumpster in the case of Derek. All that dirty work and they’re no closer to proving that Livefy trashed their offices and drained their bank account. And, they still don’t have those stolen prototypes that Bryn worked so hard to develop.

It looks like dumpster diving isn’t the only dirty business Derek is involved in these days. That pesky harassment lawsuit his assistant filed against him last season just won’t go away, something Josie Hersh interrupted his nice dinner of avocado stuffed avocados to remind him of. Seems like June Pepper caught him at just the right time — he was desperate and her offer seemed like the only way to resolve his issue, especially with the current prospects of C3D.

Unfortunately lawsuits, whether legitimate or spurious, are a major threat, especially to small businesses. That’s another way insurance can help small businesses. Instead of draining their cashflow to defend themselves, an insurance policy may cover these costs which will help with liquidity if the suit is effecting operations. Better to be safe than sorry is a good approach. Basically, do the opposite of what Derek’s doing these days.

Now it looks like C3D’s biggest embarrassment might turn into the best opportunity to get the funding they need to get their product launched on time. The mobile flour bomb was as unexpected as it was strange. Really, who’s in charge of security for their office?

The TechStars competition looks like it might be just what they need to get the funding to finish the prototypes in time for the new, early launch date. TechStars knows how to give startups the advice, tools and funding they need to be successful. But, the competition will be tough. I wish our favorite startup would do something to give us confidence that they’re up to the task.

Can’t wait to see what happens next episode. Until then, keep your office doors locked and watch out for those flour robots!