Throughout my career I have been a consistent advocate of the increasing role that treasurers play in their organisations. Today that role is crucial in the interplay of risk and governance. The treasury function must be an avenue to profitable growth in good times and, in today’s fast-moving markets, must also be the guardian of downside risk through fast, effective governance.
British industrialist James Hanson, when finally forced to introduce independent non-executive directors said: “I want people who will help me grow the business, not watchdogs.” He was right and wrong. You need both.
The ability to grow a business and be a watchdog is perfectly enshrined in insurance, which provides access to capital, or more accurately ‘contingent capital’, when a company needs the protection its insurance policies set out. When working properly, insurance enables a business to focus with confidence on growth, having protected the downside by mitigating certain risks.
But this pandemic is going to critically highlight some of the current deficiencies in insurance, which will seriously diminish the certainty of a company’s contingent capital. My purpose is to bring out some of these areas and give suggestions as to what can be done.
I start where all good governance should start – at the board. Insured risks are rarely reviewed at board level and are deemed to be 100% covered (unless the policy includes an element of self-insurance). Yet studies have comprehensively shown that 45% of larger claims are disputed. They then take an average of three years to settle and the average settlement is only 60% of the value of the initial claim. The pandemic has already caused a large number of claims and many of these are being disputed. This situation will worsen across a broad range of insurance lines such as business interruption, directors and officers, and professional indemnity.
In order to accurately assess the risk to the business, there needs to be realistic assessment of the effectiveness of the insurance mitigation, ie is the mitigation 40%, 60% or 80% covered? Then it is incumbent on the finance director through treasury and/or the insurance department to see what actions can be taken to get the mitigation as close to 100% as possible.
In hard times, I have always found going back to the basics pays. There is nothing more basic than the wordings in your policies and, unfortunately, nothing in greater need of a thorough review.
As a non-executive director of Mactavish, an independent outsourced insurance buyer and claims dispute resolution service, I have heard – over many years – just how far coverage can be eroded over time. In just the past few weeks, a company found that all business interruption, as well as infectious disease cover, had been removed at last renewal without reference to the client. You can imagine their disappointment when they turned to their insurer to compensate them for COVID-19-related losses.
I have heard of a hospitality firm that was provided with insurance that explicitly ruled out any activity related to catering. While disturbing, one’s natural reaction is to think, “that won’t happen to me”. However, it’s important to recognise that over the years policies are negotiated, and layers and layers of new wording are put in. Not only this, but as the company grows, new divisions are bought and others are sold. The wordings of old policies are often no longer appropriate. It is not surprising that insurers in good times, never mind hard times, will look for the inappropriate wordings to dispute the claim in the knowledge that they will settle ultimately at a lower price.
It is important to recognise that insurance over the past 15 years has been treated as a cheap commodity. Unfortunately, the pandemic has caused further disruption and considerable losses for the market. Lloyds estimates that, in the round, insurers stand to lose more than $200bn in both COVID-19-related claims and investment losses. As a result, capacity will be withdrawn from the market, premiums will increase significantly and the quality of cover will more than likely continue to deteriorate.
As we have not experienced conditions like this since the aftermath of the World Trade Center attacks, many of you reading this will not have experienced the effects of a hardening insurance market. I can hear you now saying: “Well, that’s what we pay brokers to mitigate for us.” Beware: the British Insurance Brokers’ Association put it in a nutshell: “Brokers are the agent of the client as well as the insurer.” In effect, they are intermediaries.
Let me be clear. Brokers are a critical feature of a well-performing insurance industry and should be an essential feature of a company’s closest relationships. But recent research using data from UK regulator the Financial Conduct Authority shows that some brokers may receive up to 78% of their income from insurance providers and the rest in direct fee income from clients. Worse, much of the money that may be derived from the insurance companies is linked to the premium value, meaning brokers will likely make more as rates increase. The potential for conflicts of interest is immense.
Insurance is purchased to protect the balance sheet and cash flows of the business and, in these times, it is my strong belief that a greater standard of governance over the process is required. There are a number of areas that I would urge you to look at.
Firstly, if you have had a claim repudiated by your insurance provider, do not accept that at face value – and do not rely only on your broker. Get direct legal advice and specialist insurance claims guidance.
Secondly, start your renewal process early and employ specialist independent advisers where necessary. A really well-run renewal process (utilising, in harmony, the broker, the lawyer and an insurance specialist) would review the risks in the business: referencing current policies in the context of current business operations and risk; assessing any gaps in current cover; reviewing cover no longer required and taking into account amounts of self insurance to ensure there is a clear set of requirements for the renewed policy. It is also advisable to review policy wordings; structuring the policy and ensuring you are sourcing the whole market for the best policies at the best price will ensure you have an effective renewal. My experience has shown that where a well-structured process of fully understood risk is demonstrated, it is very difficult for the insurer to repudiate the policy.
To achieve this on renewal, you should question your broker on how they have approached the market and which insurance companies they have approached. Then question them on the fees they receive from each of those insurers. The answer should cover not just commissions received, but facility management fees, portfolio level arrangements, profit shares and fees covering a range of services brokers provide under the title ‘ISB’.
This level of transparency will ensure that you can justify to your board that proper governance has gone into the renewal and that the insurer providing the best rates and cover for that particular policy has both been approached and selected.
Finally, a very extensive and well-run broker tender will give you a much better feel of how to work with your broker, lawyer, insurance specialist and insurance providers over what will be a very challenging time. It will give a foundation to being able to show that best practice governance has been executed. Ultimately, should you suffer a major loss, this due diligence will protect you and demonstrate that you did everything you could to ensure that your company had the best and most effective cover in place.
Paul Spencer’s treasury career spans four decades and includes periods at Rolls-Royce, Hanson and executive and non-executive roles at RSA, WPP, National Savings & Investments and Mactavish. He is a past president of the Association of Corporate Treasurers