Edition No. 9

Risk Management and the Insurance Industry

Insurance provides protection to a large group of people who agree to pay for a guarantee that a small number of people in that group will be compensated in the event that they incur a financial loss covered under the provisions of the policy. The system allows a large number of individuals to share the losses of a few in such a way that the losses do not become a burden for anyone in the group. In essence, the payment of insurance premiums by members of the group is an exchange of uncertainty-of-loss to the insurance company for a cost.

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The validity of most insurance systems is based on statistics resulting from the analysis of a large volume of information. These statistics allow accurate future predictions to be made based on past experience and historical observations. For example, given the entire population of the United States it can be predicted with great accuracy what percentage of individuals of a certain age will die next year. For an insurance company, it is crucial to sell insurance coverage to a large and diverse group such that the statistics of loss within that group will be predictable.

Balancing Losses

The pricing of insurance is based in part on losses within a group coinciding with statistical loss expectations. An insurance company can easily find itself in financial difficulty if actual losses are greater than expected losses. Conversely, lower than expected losses lead to higher profits and more competitive policy pricing. Ensuring that losses within an insured group are within or lower than statistical expectations is a never-ending goal in the insurance business.

There are a number of ways in which the statistical loss expectations of an insured group can be skewed for better or for worse. For the purpose of this article we will consider one for the better - Risk Management. Risk management may be defined as being in control of the chance or possibility of loss. In theory, the better the risk management within a group the better the chance of successfully reducing certain losses below those statistically expected from that group.

Risk Management

In the commercial and industrial insurance business, the evaluation of risk management is generally accomplished through a Risk Assessment Survey. The purpose of a risk assessment survey is to identify risk management strengths and weaknesses of individual members within the insured group.

A trained Risk Management Specialist conducts risk assessment surveys. This person is generally a college graduate, educated in a technical discipline and possessing one or more professional certifications. The specialist often has work experience in a group similar to the one he/she is surveying.

During the survey, the specialist interviews an individual group member, let’s say ABC Company, by asking a series of specially selected questions. ABC Company’s operations may also be observed. A written report, based on the information gathered, is then prepared. In the report, the specialist makes an evaluation of relative risk compared to other companies similar to ABC Company with whom the specialist is familiar. ABC Company is encouraged to address any weaknesses identified by the specialist by making appropriate changes to reduce the risk. Companies with identified strengths function to provide learning opportunities for other companies. The Risk Management Specialist acts as the conduit between companies providing positive feedback to all.

Risk Assessment

During the risk assessment evaluation the risk management specialist will ask a wide variety of questions directly and indirectly related to the insurance coverage that the group member carries. Often it is not obvious how some survey questions relate to risk management and/or insurance. It is important to keep in mind that it is the statistical significance of the information collected that forms the basis for effective risk management. Until a large amount of varied information is collected, analyzed, and compared, it is impossible to determine which factors truly contribute to effective risk management. The survey answers of each group member contribute to an on-going refinement of those factors.

Benefits

Good risk management is a win-win for everyone. For the insurance industry, providing risk management services to its policyholders favors having fewer or less expensive claims. This results in improved profits and offers the opportunity for more competitive policy pricing. For the insured, it reduces the potential for undesirable occurrences that may incur higher insurance premiums and reduce policy coverage.

At EORM, our Risk Management Services group has over 50 combined years of expertise in conducting insurance risk assessment surveys. Our experience allows us to conduct surveys quickly and efficiently at low cost. Survey reports are written in a manner that focuses on the issues and eliminates the fluff. And, our recommendations are made with due consideration of cost vs. benefit to the insured.