As Supply Outpaced Demand, Insurance Costs Slid

Despite a year that exposed risks around every corner, the total cost of risk fell in 2008.

With the bad name that risk-taking of all sorts is being strapped with these days, corporations have pulled back on activities that contain the slightest amounts of peril. Following the law of supply and demand, the cost of limiting those risks has plummeted. Thus, even as financial markets churned, and the annual tally of natural disasters reached the second-highest level on record, the total cost of risk fell by nearly 10% last year, according to the latest Benchmark Survey released by the Risk and Insurance Management Society (RIMS).  

Falling insurance premiums largely drove the decline of the metric, which fell to $10.68 per $1,000 in revenue in 2008 from $11.78 per $1,000 of revenue for 2007. The average premium cost fell across almost every category of risk, according to the study, which includes data on more than 1,300 companies in the U.S. and Canada. (Total cost of risk is the sum of insurance premiums, retained losses, and risk management administrative costs per $1,000 of revenue.)

“You would think that, given the current state of affairs in the world and the insurance market. there would be a little more sanity prevailing and rates would be stable or rising,” says Dave Bradford, the executive vice president of Advisen, an insurance-advisory firm, and the editor-in-chief of the survey. “But even though there was a massive loss of [insurance] capacity in 2008 as a result of investment losses, the insurance industry is still a bit over-capitalized, and that keeps the pressure on rates.”

In contrast to the plentiful supply, the demand for insurance has been shrinking because of the recession. Wayne Salen, director of risk management at the West Palm Beach, Fla. industrial staffing firm Labor Finders International, says that although his business has held up reasonably well, “because of the credit constraints and financial circumstances, a lot of other people are pulling in their horns on a lot of things, and that translates to exposure reductions.” He also suspects that carriers and brokers are trying to hold on to market share and are keeping their rates low in order to effectively compete. “There’s no question that for us, our cost of risk is down,” he says.

Besides simply having less business to insure, Bradford says, many companies under financial pressure, have been “digging in their heels” when it comes to renewing their policies and forcing providers to meet their budgets. Risk managers are also exploring alternatives to traditional insurance to keep their costs down, he adds.

Some are increasing the amount of risk they retain on their own books and others are setting up captive insurance subsidiaries or making greater use of the captives they already have. Other companies have focused on another component of the cost of risk: they have reduced the size of their risk management staffs, a move that Salen notes, “looks good at the moment, but can be exceptionally expensive down the road.

“Despite the overall softness of the insurance market, some companies, particularly those that are already troubled, are not benefiting from the trend towards declining costs, finding insurance in certain areas to be both expensive and hard to come by. “The area where there’s particular distress is the directors’ and officers’ liability line,” says Bradford. “Those that are in the financial sector and have been bloodied by the credit crisis and the subprime debacle are either having trouble finding enough coverage or seeing rates increase substantially.” Underwriters are also scrutinizing highly-leveraged companies in an effort to determine whether they can manage their debt loads and are risks worth insuring. 

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