Not many things are what they seem when it comes to an insurance policy so when we find something that seems straightforward and actually is we should all rejoice. “Medical Payments” found in the General Liability policy is a coverage that is what it sounds like it should be, it pays for medical costs that third parties incur. This being insurance of course there is a bit more to it as the 2 minute video below will explain.
We can learn about risk management and insurance from our daily lives? Think about the times you may have gotten injured or something went wrong in your life that was preventable by incorporating risk management activities into your life. Right now I am going through one of those times in my life.
I am an avid runner but have been suffering through a foot injury all autumn which has prohibited me from running and doing pretty much any other exercise that requires me to put weight on my foot. To add insult to injury (pun intended), the fall is the prime racing season in distance running so I have not been able to race either. Granted, I am no Olympian by any stretch, but I like to challenge myself and get my competitive juices flowing so not being able to race, let alone run, has been very difficult for me.
So how does risk management play into this? First, the injury wasn’t due to some freak accident, it was caused most likely by my lack of doing the ancillary work I should have been doing to take care of my body. If I had stretched, done more strength work, and listened more to my body I probably would not be in the position of having to stay off of my foot. To put it bluntly, if I had done the things (risk management) that I know help prevent injury (loss) but I don’t really enjoy doing I would probably not be injured now.
According to my doctor I will be fine with rest and recuperation but that will take time. Even though I will be fine and my financial cost is limited, that does not mean I will come away unscathed from this injury. There are direct and indirect costs that cannot be redeemed. My stress levels were increased because I could no longer use running and exercise as a release. My health most definitely took a step back. I am sure there were other impacts as well, but the point is even when we are made whole after a loss we still suffer losses that we cannot recover.
We all know there are certain things we should be doing to prevent losses but don’t do them. I don’t do enough stretching, although I like to take comfort in the fact that I am sure I am not the only one not stretching as much as I should. Many companies don’t do the things they should be when it comes to risk management and they too can take solace in the fact their peers aren’t either. There are many reasons why companies don’t implement a risk management program, it could be a lack of resources, either financial or personnel, not knowing how to implement risk management, or it could be they just don’t see an ROI from risk management and therefore won’t even entertain the idea. Whatever the reason might be, in hindsight we all wish we would have done things differently after a loss, especially if we know it could have been prevented.
The less prepared you are the more a loss will hurt, trust me, I am experiencing this right now. Many companies don’t realize that insurance companies want to help you implement a risk management program. Insurance companies realize that investing in preventing a loss is much better for their bottom line then paying claims. What is surprising is how often new clients do not realize that these resources are available and that they cost you nothing, but their prior insurance broker never told them they were available. Your insurance broker should be more than someone who simply transacts an insurance placement on your behalf, they should be helping you manage your risk. This can be done by making sure your policy is actually covering what you need it to cover and helping you find ways to prevent losses in the first place.
Do you remember when insurance companies had to make significant reserve adjustments for Asbestos claims in the early 2000s even though the exposure happened years ago? I worked for Hartford at the time, on their investment side, and even though our sales were great, Hartford’s earnings always seemed to disappoint because they kept having to increase the reserves to pay for asbestos exposure claims that were just starting to be filed even though the asbestos exposure may have occurred decades ago. If you look at your insurance policy you might even see an exclusion titled “Absolute Asbestos Exclusion” that makes clear that any new asbestos exposure will not be covered in the future
Insurance policy wording is shaped by claims that have been paid by the insurance company that they never intended or imagined they would be paying. Asbestos is a pefect example of this happening on a catastrophic level. A large number of people were exposed to Asbestos and it took years to realize the damage that asbestos exposure inflicted on the human body. Today, anytime a claim is contested in court and the insurance company loses we can expect to see policy language change so that the insurance company does have to cover similar claim again. The old saying, “fool me once, shame on you, fool me twice, shame on me,” is alive and wellin the insurance world.
Like asbestos, there will always be risks that do not show their ugly head until years after we have been exposed to them, creating challenges for the insurance companies. Insurance companies cannot underwrite and reserve for losses they are not aware of. I tell you all of this for two reasons:
- Your insurance policy is always changing, even if your broker tells you there are no changes, things are always changing. It could be as simply as a form being updated to comply with state requirements or it could be the addition of a form or wording that excludes all “claims arising from electronic communication.”
- It allows me to share this great video on E-cigarretes I found on Twitter that is a good example of demonstrating that we don’t know always know or understand all the risks that a product might have.
The dude vaping is actually from Barstool Sports and was trolling Laura Ingrahm but the point of unknown risks still prevails.
In college I studied economics but never believed in its practicality and as a result my grades in the subject reflected my disillusionment. The ideas only made sense if the world was perfectly rational, but as we all know the world is not rational and that is why economic theory is just that – theory. Actually, the world is rational, it is humans that are not.
So why would do I bring behavioral economics up on an insurance blog? I think we first have to understand what behavioral economics is. Behavioral economics is the study of why individuals and institutions make the decisions they do in spite of the fact that those decisions are often not the most efficient or rational decisions, people make decisions based on emotion. For example, if I have a fair coin and you win $600 if it is heads, but if it is tails you lose $400, most people will turn this bet down even though the expected outcome is for you to win $100 ($600 x 0.5 + 400 x 0.5 = $100). The reason people turn the bet down is because of risk aversion, the fear of losing outweighs the happiness of winning. According to studies, the potential for gain needs to be at least twice the pain you suffer from a loss, so in our example, if you could win $800 if it heads, but still only lose $400 if it is tails, most people would take the bet.
Now that we understand Expected Value or Expected Outcome let’s discuss how that relates to insurance. The rational choice for consumers would be that when the premium plus the deductible is less than the Expected Value we buy insurance as shown below:
Insurance premium + deductible ≤ Expected Value
As discussed, we dislike pain (losing) twice as much as we enjoy pleasure (winning) so we won’t buy insurance or forego insurance based on the premium compared to the expected value, we will be willing to pay more than Expected Value. However, because there is such a large delta between Expected Loss Value and Maximum Loss Value the mindset changes.
This is where it gets tricky because we buy insurance to protect us against events that could cause large financial loss but that have a low probability of occurring. Insurers typically can’t get away with charging double the Expected Value because the probability of an insured loss occurring is much lower than a coin flip and we can’t define the amount of the loss beforehand, it is vague. At this point insurers and actuaries will start talking about Utility Theory. Utility Theory supposedly will determine how much an insured will pay above the Expected Loss Value for their insurance. I personally believe Utility Theory is hogwash when it comes to insureds buying insurance.
If you have ever bought insurance at all, be it as an individual, a Risk Manager, or a CFO, have you ever been told what the Expected Value of your losses is for the next 12 months? My guess is you have not. There are ways to back into Expected Value based on aggregated data, at least an approximation, but it is not much use unless you are in a position to self-insure. The market is the market, meaning if we don’t like the cost that is too bad. We are often compelled to buy insurance because of mortgages, contracts, statutory requirements and social norms. We don’t calculate the Utility of buying or not buying insurance because we don’t feel like we have a choice, it is something that we just have to have because that is the way it has always been.
The insurance carriers are the ones that are determining how much risk they are comfortable taking on, it is not the insureds. Most insureds are buying based on price and if they are not it is still a key consideration. If an insured buys a new type of insurance coverage, they are then buying because they have a new exposure (bought a car/cyber insurance) or because of “herd mentality,” meaning they are doing what their peers are doing. “Herd Mentality” is why brokers show benchmarking (how much or what peers are buying), if a board of directors knows that peers are buying more limit for their D&O insurance then that company will probably buy more to keep up and feel more comfortable. Why insured
As I said, insurers are the ones that determine how much of a premium over Expected Value is required for them to take on your risk. The data they all use is similar, so their Expected Values should all be fairly close to each other. There could be a number of different reasons why pricing varies, such as:
- A carrier might be new to that particular market or industry so they either underprice to steal market share or overprice because they want to test the waters first.
- A carrier could have been lucky or unlucky and their losses vary significantly from their peers despite having similar underwriting standards.
- The devil could be in the details. Coverage might look the same from a high-level but there are key differences in coverage wording or policy sub-limits.
The third point is the key point for insureds because this is where you mold coverage based on how risk adverse you might be. A policy that is broadly worded will give you more coverage and most likely carry a premium to a policy that is narrowly worded. Sub-limits are something you want to pay close attention to as well. Sub-limits are something that the carrier provides either as a selling feature, meaning they will never be used, or because the carrier wants to restrict coverage to particular risks that they believe have a higher probability of occurring. Two examples of restrictive sub-limits that have a higher probability of occurring are “backup of sewers and drains” on your homeowner’s policy (probably on your commercial property policy or BOP as well) and “spoilage” on a commercial property policy.
When buying insurance, understand that insurance purchases are usually made with the past of least resistance. We buy the insurance we “need” because a third party mandates that we have it. We do not think about Expected Loss Value or the Risk Premium, we just understand that insurance is there to protect us when a low probability event causes us to have a financial loss. Trying to determine Expected Loss Value and Risk Premium are wastes of time, but if we instead try to pinpoint where an insurance company is restricting coverage we will most likely be able to better determine what risks or types of losses have the highest probability of occurring and have the highest Expected Loss Values. Remember, the insurance company writes the policy and they make more money when there are fewer claims. This is where it is important to have a broker that understands your business risks but also has a deep understanding of your insurance policies – just because something appears similar does not mean it is.
Two of my kids have peanut allergies which makes Halloween a bit stressful around our house. Fortunately, our kids’ reactions are not as bad as I know some other people have it so candy in a wrapper won’t cause them to have a reaction. They can still go trick-or-treating and my wife and I don’t have to worry about them having a reaction half-way through the night.
Our stress comes after we have gotten home and we start to go through the candy. We need to sort out everything that has peanuts in it and the candy we aren’t familiar with we need to check the label. Every year we do this at least one piece of candy seems to slip by and cause a reaction, thankfully we have never had a terrible reaction, but any reaction unnerves you as a parent.
Why I bring this up is because it is similar to when I audit a prospect’s insurance program. Their broker should know what risks could cripple the company, that companies “allergy.” Based on that risk assessment they should know where there might be vulnerabilities in the insurance program and doing everything they can to eliminate those coverage gaps. However, when I review prospects’ insurance policies I still almost always find numerous coverage gaps that are significant. I don’t use the word significant lightly, these are coverage gaps that could cause six figure plus losses that should otherwise be insured but aren’t. The broker isn’t getting rid of the candy with peanuts.
In the past, either me or my wife would go through the candy and put aside anything that had peanuts. Last year we started something new, I went through the candy like I always have and put aside the candy with peanuts but then my wife went through the now smaller collection of candy to make sure I did not miss anything. Sure enough, my wife found things I had missed.
Your broker is probably doing a pretty good job of making sure the obvious things are covered and does want to make sure you have no coverage gaps in your policies. The question is, how do you know they are not missing anything? My kids are the most important thing in the world to me (no offense to my clients) and I have missed pieces of candy that could do undue harm to them, so do you really believe your broker hasn’t missed anything? Wouldn’t it make sense to double check? We audit policies all the time for new prospects without charging them a dime. If we find no significant coverage gaps that is great, it means your broker is doing a good job so you should stay with them. If we do find something significant we will share it with you and show you how we can fix it for you. Either way it is a win, so shoot me and email or give me a call and we can discuss how to get started.
I read a tweet today from an attendee at a venture capital conference that said, “Opportunity is all around you, so take risks.” I 100% agree with that quote, but I would add this caveat to the end, “but eliminate risks that you can, prevent the preventable from occurring.”
Insurance should be used to eliminate the risks that can hinder a company from being successful but are unlikely to happen. Insurance works like this – you pay a relatively low premium to the insurance company and in return they make you whole financially in the event you suffer a loss. The lower the probability of loss occurring, the lower your premium, and conversely, the higher the probability of loss, the higher your premium. A more technical way to look at is that premiums are the outcome of discounted future losses plus some profit for the insurance company.
I go into this because it should help companies understand what types of insurable (i.e. preventable) losses are most likely to occur. Insurance companies spend a lot of money on data and analytics to better understand the probability of risk, knowing how and why they price your risk the way they do might help you determine where it makes the most sense to insure or self-insure. For example, public company Directors and Officers insurance has premiums that are multiples of what a private company would pay for Directors & Officers because losses are larger and more likely to occur. Workers Compensation insurance is inexpensive for a life science company that outsources R&D but for a construction company that might be the biggest insurance spend they have.
How should companies approach “preventing the preventable?” Companies should first figure out what can be insured and what can’t be insured, cost should not even enter the conversation at this point. Companies can do this by sitting down with their broker and identifying all the risks that a company faces. The broker’s job is to then recognize which of those risks are insurable. For instance, you may point to a large company infringing on your patent and your broker should be able to tell you that yes, you can insure the costs to defend your patent. Once the insurable risks are determined then you go through the process of figuring out what it will cost to insure and making a determination of where to spend your insurance dollars. Remember, the larger the premium the more likely a risk is to occur.
Concept or Concrete? Are you buying insurance based off of a concept that your broker is proposing or off of facts? If you have perfect coverage with no gaps that is fine concept is fine, but otherwise you should be thinking about buying off of fact.
What do I mean by fact? As a broker, I review prospects policies and report to them what isn’t covered that easily and inexpensively could be covered. I am not talking about small issues, but issues that could dramatically impact a company’s balance sheet, six and seven figure coverage gaps. You probably believe you don’t have these coverage gaps and you wouldn’t be alone. I would say 60-70% of prospects we talk to believe they have no coverage issues or minor issues, but for 95% of the companies we have performed a coverage audit for we found at least one or more 6 figure coverage gaps.
Most brokers will come in and say we want to do this and that for you. They won’t actually do what no one, not even brokers, want to do and that is read your policies and tell you what you have and what you don’t have. Guess what? That is what we do and that is why we can sell on fact. We tell you what is good, bad and ugly and then how we can fix it.
One last nugget from my trip to Boston:
I hope everyone has a great weekend!