Home > Property & Casualty > Lloyd’s Chair warns middle market to be watchful

Lloyd’s Chair warns middle market to be watchful

nelsonThe insurance industry is rarely thought of as a vehicle for financial innovation and experimentation. The fundamentals of the industry often seem very basic to non-insurance people. In short, you pay a premium to cover claims made against the insurance policy. The trick for the insurance carrier is to take in more premiums that losses paid out in claims. Seems pretty simple, right?

For those of us who live in this industry, that simple model is actually much more complicated. Complex risks and alternative risk transfer options do offer the industry the opportunity to be innovative and, believe it or not creative in the risk financing world. However, we can never ignore the fundamentals for too long before an insurance company faces insolvency or the insurance buyers face higher premiums for their coverage needs. It is exactly this concern that the Chairman of Lloyds of London raised at a recent speech.

John Nelson sounded the alarm about possible risks associated with the massive amounts of capital that have recently entered into the insurance industry. He noted that “non-traditional” sources of capital were entering the business “on a scale not seen before”. He warned that this new reality should be a cause of concern for the industry and buyers of insurance across the globe. Like the banking sector, Nelson’s concern lies with the separation of risk from the capital itself.

Nelson warning should carry somewhat more weight than others who might make a similar warning as he came to Lloyds of London from the banking sector. He was a first-hand witness of the financial meltdown that took place within most developed economies around the world. And like the mortgage crisis in the US, the insurance industry faces the very real prospect of good money chasing after bad risks. Just as if a bank were to make a loan to a homeowner that is a poor credit risk, some of the new capital into the risk financing field looks to be chasing “transactional returns” rather than underwriting profits. A loosening of strong underwriting standards and “automatic placements” runs the risk of removing the evaluation of the risk from the cost of the risk itself. In short, if there is always “access capacity” and there is little need to have the market underwrite the risk exposures, underwriting quality is at risk of deterioration and underwriting losses are sure to follow.

So how does this impact the middle market buyer of insurance? In short, if underwriters can lower their prices (for primary, excess and reinsurance contracts) without the concern of excess capital to protect them from “shock” or catastrophic losses, they are less likely to be vigilant about the quality of the risks that they underwrite. The lure of a return to “cash flow” underwriting may prove too attractive in the near-term and artificially keep pricing lower than they need to be. And while this is attractive to insurance consumers, the “boomerang” effect that results in spikes in insurance and reinsurance rates has a far more negative impact on the overall economy than any positive e benefit of a short-term premium reduction.

None of this is to say that we should dismiss this new capital and the new risk vehicles that are becoming available in the market. Rather, as Mr. Nelson points out, we all must be “extremely watchful” and learn from the past. Santayana was never more accurate when he said that those ignorant (and I would add dismissive of) the past are condemned to repeat it. That won’t be good for any of us.

About the Author

Pete Reilly is a Senior Vice President and the Healthcare Practice Leader at WGA, with extensive knowledge in healthcare systems, including hospitals, long-term care facilities, and medical practice groups of all sizes.

617.692.0256 | PReilly@wgains.com | Connect with Pete on LinkedIn
Follow Pete @MedMalInsGuy

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