I have recently sat through a series of underwriter presentations, where some of the underwriters said they were pleasantly shocked by the level of disclosure they received. Somewhat surprised, I asked ‘why pleasantly’? It seems that the overall level of disclosure they see is getting progressively lower and more formulaic. They said it made a very pleasant change to feel like they were really connecting with the risk and those managing it.
Well, that all sounds very nice but, so what? Well, for the kind of insurances I tend to handle - unusual, complex and novel insurances - I believe that the style, form and substance of disclosure provided by a buyer is critical to the success of the placement. Full and accurate disclosure is critical to any placement of course but there is disclosure, full disclosure and then there is the real thing. With unusual, complex or novel coverage (UCN coverage from now on) I believe only the real thing will do.
This piece is about what the real thing is and why it is important. Another time, I will need to reflect on what the underwriters’ shock means for UCN insurance. From what they said, one could infer either that there is less UCN exposure, which I simply don’t believe or that UCN exposure is less disclosed - however you define that term – and I am not quite sure what I think about that…
First then, some background on UCN coverage.
UCN coverage is what it sounds like:
- Unusual means that it is rare, so there is not enough to make up a portfolio of it. This means that, instead of the insurer being able to price for the volatility of the performance of a portfolio, which is the core of what insurers do, they have to price the underlying risk. This is a much more complicated, expensive and uncertain process.
- Complex can mean that different perils are covered under the same policy but real complexity occurs when the underlying nature of the risk is maybe dynamic, interconnected in non obvious ways with other perils or otherwise inherently messy – normally because it deals with what we (humans) do or don’t do, as opposed for example, to the effect of bad weather.
- Novel coverage deals with risk that it is not yet well understood; various forms of cyber risk currently fall into this category.
Second, some background on disclosure.
Disclosure means different things in different places. The key differences are evident between the US and the UK – where other places tend to adopt one or the other approach.
- Very crudely, in the US, the prospective insured is required to fully and honestly answer the questions posed of it by the insurer and, if the insurer doesn’t ask, the buyer doesn’t have to reveal. I repeat, before being bombarded by lawyers, this is crude. In my continuum above, this is ‘disclosure‘.
- In the UK on the other hand, the onus is reversed. The insured is under an obligation to disclose anything that might be material to the insurer’s acceptance or pricing of the risk, whatever the insurer does or doesn’t ask. Naturally, this is an almost impossible requirement to fulfil, the more so, the more UCN the risk. This is ‘full disclosure‘.
- The ‘real thing‘ is the sharing of drains up information about how you understand the exposure, with the colour of what it means for how you are going to (and who is going to) deal with it from soup to nuts.
The ‘real thing’ has three elements. It involves:
- Soup to nuts – it addresses the entire process of understanding and managing the particular risk, including the full context of the risk;
- Drains-up – it is an in depth review; it is not superficial; and
- Sharing – both parties share what they know to ensure the residual uncertainty is about the risk, not about the difference between what each of them knows. This also involves bringing together the personalities who will be dealing with the risk – again on both sides. This adds the real colour to the process.
Bringing UCN coverage together with disclosure, the thing that is common to all UCN risk is that portfolio management approaches to managing it don’t work very well – or at all. Modelling, the foundation of portfolio management, has become extremely sophisticated but you need a base of reliable data to start working with a model and you need to be able to make reasonably reliable assumptions to extrapolate from the base with confidence. Disclosure is one of the key sources of both the raw data and of the material needed to make reasonable assumptions. NOTE: in an increasingly ‘big data’ world, it is clearly not the only source – and may in future not even be much of a source at all but that is for another post.
I am not saying UCN risk is unmeasurable, far from it; I am saying however that, by its nature, it is not measurable to the same level of confidence that insurers are used to and this can make them extremely uncomfortable. My contention is that you therefore need to disclose more to try to fill the gap between what they are used to getting with better understood exposures and what you can provide or they already know relating to your particular UCN risk. In this sense:
- ‘disclosure’ doesn’t result in better understanding, it really only confirms what an insurer thought they already knew;
- ‘full disclosure’ adds what the buyer knows about the risk – which may or may not add to what the insurer knows generally or fill in some specific details in an alpha and beta sort of a way; and
- the ‘real thing’ on the other hand is designed to compliment data by delivering a rich and colourful mental model of the risk.
Whether you add what that mental model tells you to your formal model or not, the colour and the personalities are the key. Data narrows the uncertainty of the number of possible outcomes or the costs therefrom to some extent but with UCN risk, can only go so far. The result is that a probably higher than truly necessary premium will still be required as far as the insurer is concerned (compared to the genuine risk premium), to deal with the greater uncertainty than they are used to that remains. Of course, if the certainty remains too great, the coverage won’t happen at all.
The purpose of the colour is to bridge the gap between not enough and enough, by influencing how we make decisions. We (humans) tend to be naturally biased towards optimism when we make decisions. The more we think we know about a situation, the more confident/less uncertain we are about it. As a buyer adding colour to what is already known by the underwriter, you are feeding their optimism bias, giving the underwriter far greater scope to say ‘yes’ to what you are asking for.
In my experience, there are four main benefits to the ‘real thing’ and, subject to the cost of disclosure and the importance of the risk to you, they apply to some extent to any risk or insurance policy:
- As already discussed, high levels of colourful disclosure make it more likely that the coverage you want will be available at all; and
- As also discussed, the more UCN the risk, the greater the disclosure, the lower the cost of the coverage compared to what is available with lower levels of disclosure.
- The quality of the contract is also improved. I often see that the quality of coverage low disclosers get is not as good as it could be. High disclosers on the other hand, can get coverage low disclosers can only dream about. For example, the extent of in-house claims handling latitude a high discloser can get, can bear no resemblance whatsoever to what most buyers have to contend with.
- Probably the biggest benefit however, after availability, price and coverage (what have the Romans ever done for us…?) relates to claims handling. Now, while it is true that there will be more scope to be creative with situations at the fringes of what is intended to be covered if you have done everything you can to jointly contemplate what should be in the policy, I can’t pretend that illegitimate claims will ever be paid. That said however, the outcome of any claim – whether against a buyer or subsequently against an insurer (I am a casualty snob; I always think in terms of liability) – is never determined only by the facts of the event giving rise to the claim in the first place. There is just too much else that goes on, and that can go wrong, for that to be the case. In my experience, almost the only two things you can be certain about every claim are:
- that you never know at the beginning of a claim journey everything that you will know about it by the end of the journey. You can reasonably expect to be surprised and a healthy skepticism about what you think you know at the outset is not necessarily unhelpful; and
- it is not so much that ‘whatever can go wrong will go wrong’ but that, in addition to the original proximate cause of the claim in the first place, one or more other things are also likely to go wrong (or to have gone wrong) in the chain of events leading to the final disposition of the claim. It might be before the event (or even have caused it), it might be during the event itself, in the notification of the subsequent claim or sometime during the negotiation with the plaintiff or with the insurer – or any one of a number of other places and times. The colour of the ‘real thing’ ensures all this ground has been covered when you are writing the policy, not when stuff and fan are coming together.
When a buyer’s uncertainty – the reason they want UCN coverage in the first place – is compounded with the insurer’s uncertainty – whether to accept the UCN risk and what to charge for it – it seems to me to be axiomatic that disclosure needs to be much more than ‘disclosure’ or ‘full disclosure’. The ‘real thing’ is something shared between buyer and insurer and involves transparency about everything about the risk the insurer is really accepting.