New world for risk management

Like a man waking to find that the Earth is flat after all, the risk management profession must be calling into question some of its dearest held beliefs. The financial services sector, that most lovingly regulated of machines, surfeited with risk committees and swaddled in governance, has come close to collapse.

Back in June, as Lehman’s troubles started to become apparent, one blog contributor to The New York Times wrote: “The disciplined risk management that they are known for? Those risk managers must have been out to lunch … for the past four years or so.”

That neatly sums up the continuing incredulity that risk management could fail so badly. The profession’s image has taken a severe knock.

So will companies show “risk management” the door and return to the days of the “insurance buyer”, upping their spend in the process? Not necessarily – for part of risk management’s existential nightmare is the fate of AIG. If AIG has to be salvaged by the US taxpayer because of a crazed love affair with credit default swaps, who else may have been playing equally risky games? We have now heard too many “business as usual” statements followed by revelations of massive write-downs for such assurances to be trusted.

Risk managers will be asking their brokers the kind of “what if” questions that would not have crossed their minds a year ago. Even where they can be reassured that their policies will ultimately be honoured, questions over delays in claims handling and worries about the administrative nightmares that would follow a big insurance failure must weigh heavily.

Add to this the fact that a severe economic downturn is moving from a possibility to a probability and companies are likely to be drawing in their horns. First to go will be the spending on emerging risks. Insuring against the fallout from an avian flu pandemic at some uncertain time in the future will seem something of a frippery if the business may not survive to witness it.

The same goes for terrorism and almost certainly for anything to do with the environment if companies reckon their exposure to environmental liability is less than life-threatening. The balance between those risks that can be retained in-house and those that must be transferred will be reassessed – and probably not in favour of upping spend on insurance.

The reaction is likely to be overdone – and wrong. You do not cure cancer by getting more rest. Sensible businesses even now should be clearing a space in the boardroom for risk management and strengthening, not weakening, its hand. Buyers of insurance should be actively looking for reliability and efficiency rather than cheapness and the insurance industry in turn should be upping its game in providing top-class service, notably in contract certainty and claims handling.

The purgative of the current turmoil may have beneficial long-term effects. But don’t expect to have a happy time meanwhile.

andrew.leslie1@btopenworld.com

Key points

• Insurance buyers will question the financial stability of insurers

• Spending on peripheral insurance products will be cut

• Risk retention will increase

• Insurers must focus on service