Risk Management Reports

“Another opening, another show,” wrote Cole Porter in “Kiss Me Kate,” Here we are opening the 27th volume of Risk Management Reports in a year with three naughts. Given luck (and proper risk management), my readers will have avoided any computer unpleasantness and are ready to face other risk issues for this new year.

My 1999 issues sported both hits and misses. I forecast the bursting of the stock bubble in the US (for the second straight year) and found myself staring again at new market records, wondering why I put my money into Treasury bills. Political and military turmoil also topped the list: no miss here, with impeachment in the US, Kosovo, India-Pakistan, Iraq, Indonesia and Northern Ireland leaping out of the headlines. Other correct calls riveting our attention were the continuing legal hysteria in the US, the Y2K problem, the development of AIDS into a huge human disaster in Central Africa, the gambling craze (again in the US), the movement toward a geriatric society in many developed countries, and the need to re-define risk management. There is a persistency to most of these issues, as you will see.

For 2000, I restrict my issues to financial institutions and trust, two areas that offer unusual opportunities and pitfalls.

First, financial institutions. We’re entering a maelstrom of rapid and tumbling change brought about by the globalization of trade and radical upheavals in regulation. Nowhere is this more apparent than in the US, where the old rules and regulations are crumbling, leaving insurance companies, depository banks and investment firms scrambling to enter each other’s businesses. After sixty-six years, these institutions may now acquire and be acquired by each other. What is likely to happen?

First, look at the condition of the insurance industry. It is in terrible shape. The property and casualty side has under-priced its product for almost 40 years, leading to the suspicion that the proper name for its employees should be undertakers, not underwriters. This resulted in under-reserving and an over-reliance on both investment income and on an out-moded distribution system (insurance agents and brokers) when other financial services are quickly moving to direct relationships. Its overhead costs are exorbitant (averaging almost 30% of each premium dollar). One securities firm suggests that the industry overspends $54 billion annually in “sloppy and redundant paper processes.” Its services have been rated by its customers as D-, almost failing: the industry has a chronic inability to deliver a policy on time without mistake, and its treatment of claimants borders on the absurd. Apparently it thinks most claimants, including its own policyholders, are inherently dishonest, and therefore it creates delays and obfuscations that fulfill its prophecy: claimants become so irate that they do, in fact, inflate losses!

Some investment analysts argue that the industry is one-third, or $100 billion, over-capitalized. They press for capital reductions to increase ROI and stock prices. At the same time, other observers warn of the rising susceptibility of insurers to wind, water and earthquake catastrophes, any one of which may sink a number of major carriers. Is it too much or too little?

Consider also the rapidly declining reputation of the industry: public outrage at medical insurers and HMOs, accused of meddling in medicine, substituting profit for sound health care; lawsuits that now forbid insurers from using secondary market, instead of OEM (original equipment manufacturer), parts for auto damages; lawsuits that re-define both coverage and exclusions; and the often-comic political machinations of less-than-reputable persons trying to become elected state insurance commissioners.

No wonder Myron Picoult, the astute industry analyst for Wasserstein Perella Securities Inc., writing in Business Insurance (September 20, 1999), says that “the industry is in a period that is both mesmeric and frightening.”

What’s likely to happen in 2000? The welcome demise of the Glass-Steagall Act, the extraordinary productivity inherent in new information technology, and the threatened change in accounting rules in the US, from “pooling-of-interests” to the “purchase” method, suggest twelve months of intense jockeying for position. Banks will be the aggressors. I doubt that they try insurance through the sales route. This sandbags them with underwriting and expense inefficiencies, plus the sad claims-handling reputation of conventional companies. I suspect they will use the next twelve months, before the new accounting rules take effect, to acquire selective property & casualty insurers with knowledgeable underwriters, modest expenses, and reasonable claims-paying reputations. If that fails, they will create underwriting vehicles de novo, blending insurance risk financing with existing banking products and services, stealing quality personnel and services from other firms. In a few, very few, cases, insurers may actually acquire banks.

The second effect in 2000 will be the acceleration of direct insurance services to customers, particularly personal and small business buyers. Insurance companies that fail to offer coverage directly may find themselves hopelessly buried with their albatross counterpart, the agency and brokerage system. The President of the Federal Reserve Bank of Dallas summarized the situation in the Wall Street Journal: “The real key to our growth in productivity is information technology and the Internet revolution. . . . the Internet’s disintermediation is squeezing it all down to wholetail.” My prediction: within five years, more than 50% of all risk financing will be purchased directly from risk financing institutions.

This, of course, does not mean that there is not a position for “advisors.” Some will succeed, but as the consultants to their clients, not as commission-paid salespeople.

One final comment about financial institutions in 2000. We have yet to conclude how best to regulate these new combinations. Will it be state/provincial, national, regional or international? In the US the utility and efficiency of state regulation of insurance is under serious question. With global competition, I believe that some form of Basle Committee will be necessary to oversee financial organizations, with all their permutations. Global risk-based capital requirements are inevitable, however much they may impinge on national sovereignty, with the resulting and inevitable chauvinistic political outcry.

So we have an extraordinary opportunity to create and deliver new risk financing products, attuned to current and future needs, blending the skills of three financial institutions æ banks, investment houses, and insurers. The pitfall is that some will not make it.

My second issue for 2000 is trust. My over-arching concern is the growing lack of trust of individuals in profit-making corporations and their governmental servants. Some of this disillusionment is evident in the frequency and size of individual and class action lawsuits that invoke even frivolous allegations. We simply can’t trust one another.

The noises from Seattle early in December illustrated the magnitude of the problem. Luddites on both sides insinuated the worst possible inclinations of the others, and the anarchists said “to hell” with everything! The World Trade Organization could not see that its deliberations should be far more transparent and reflective of broader issues than simply trade. The demonstrating groups piously intoned their concern for workers and environments in other jurisdictions while attempting to protect their own comfortable and insulated positions. Neither side could believe that the other possessed even a modicum of altruism or honesty. There was no trust.

The Economist (December 11) summarized it neatly: “Free trade, like freedom in general, is not a panacea. It is not likely to bring better welfare on its own. But also, it is not likely simply to enrich multinationals and destroy the planet. Trade is about greater competition, which weakens the power of vested interests. It is about greater opportunity for millions rather than privileges for the few.”

When we have elected officials who patently lie to us, when we have an industry deny for years that its products are harmful to our health (in the face of almost uniform scientific evidence to the contrary), when other scientists assure us of the relative safety of some technology in terms that are incomprehensible, trust is eroded. And when trust disappears, so too does civility and confidence in the uncertain future. We turn to constant threats, recriminations, and the use of lawsuits to redress imagined imbalances.

Last year’s film, A Civil Action, drawn from the earlier book of the same title, illustrates that lack of trust: the plaintiffs mistrusted neighbor corporations and even their own attorney; the corporations mistrusted the community and the civil justice system; the court mistrusted the competing lawyers. Who can we trust if everyone seems hell-bent on personal gain?.

How is the public to react when a corporation appears to value its shareholders over any other constituents? A review in the Journal of Contingencies and Crisis Management (September 1999) described the first response of the company that owned the Estonia, the ship that sank in the Baltic on the night of September 28, 1994 with the loss of 800 lives. The next morning the company advised the press that insurance covered the loss of the ship and possible ensuing damages! No wonder that the public loses trust in corporations, organizations that, in Peter Bernstein’s words, give evidence of “a ruthless and cold-blooded drive to maximize shareholder return.”

If mutual trust is rapidly disappearing, what can we do about it? Lance Odden, the Headmaster of Connecticut’s Taft School, recently wrote: “None of us can entirely change the world, but we are morally challenged to try to make it a better place.” This is as true of the organizational risk manager as it is of a teacher or preacher. Perhaps this new century will see a retreat from the “me” decade of the 1990s toward a new recognition of our interconnectedness with others, our communities, and our environment. Yes, we need to be efficient, and productive, and profitable, but not at the expense of all those values that create a livable community.

We place great stock in “scientific” risk assessment. But how does the public view it? Peter Montague, in an Internet essay that John Ross (The Polar Bear Strategy, see RMR, December 1999) brought to my attention, writes: “Risk assessment is inherently an undemocratic process because most people cannot understand the data, the calculations, or the basis for the risk assessor’s judgment.” How can we democratize the process without compromising its intellectual rigor?

The solution lies in improving how we communicate with all those affected by our decisions. There’s an eye-opening chapter in Risk and Responsibility, wr itten by William Leiss and Christina Chociolko (McGill-Queen’s University Press, 1994), that describes a power line siting controversy in British Columbia. In 1989, British Columbia Hydro proposed additions to an existing set of power lines to support a pulp and paper plant expansion. Leiss and Chociolko tell the fascinating story of the public reaction to the plan, the conflicting scientific evidence offered about the risks of electric and magnetic fields, the growing resentment of both sides in the argument, the attempt of government to intervene and arbitrate, and the conclusions, unsatisfactory to all. It’s a lesson that every risk manager should read, mark, and inwardly digest. It is a lesson of the erosion of trust and the failure to communicate intelligently and in a timely fashion. It is a lesson of how not to present so-called “expert” scientific data to the public. By the end of the affair, no one participant trusted another.

Another example is the decision by Royal Dutch Shell to sink its Brent Spar facility in the North Sea. The outcry from environmental organizations, including Greenpeace, forced the company eventually to scrap it ashore, even though most expert opinion, including that of some “greens,” was that sinking it was the least offensive to the environment. The lesson: consider seriously the views and risk perceptions of all interested parties before making a decision.

Who can we believe? How can we establish mutual credibility? That is the question that risk managers should ask in 2000 as they attempt to rebuild the bridge of trust that once existed with multiple stakeholders. We must learn how to communicate clearly and intelligently with all of our audiences.