When an insurance issue comes up, most people will call their broker with simple instructions: “Handle it.” While this approach is not uncommon, it is becoming increasingly dangerous to “abdicate” rather than delegate. Insurance and risk management programs need to be understood by boards and association members for what it is—a means of transferring the financial impact of risk from the balance sheet of the property to a third party. Managing the “moving parts” effectively will allow the organization to use insurance and non-insurance risk transfer to insulate the assets of the organization rather than having possibly significant uninsured exposure.
Seems simple, right? In theory, it is—in application, however, it is a complicated process that needs to be well choreographed and executed. With the recent catastrophic weather-related claims, (estimated over $5.5 billion since April 1st of this year) there will be increased pressure to preserve underwriting profit. This is where the insurer takes your premium and doesn’t pay a claim. It’s time to pay attention.
The risk management process is simple. You must identify and understand loss exposures, analyze and measure the financial impact, determine what risk mitigation steps are appropriate and commercially feasible, implement those risk-transfer steps and monitor the process to make sure they are producing the desired results. Working closely with advisors to assist in understanding this process and making it work for your organization is essential. Just “buying insurance” for the cheapest premium is not enough.
“What Risks, How Bad Can it Get?”
An organization needs to ask questions like this in order to understand their material risks and how those risks can be mitigated through the use of various transfer techniques, such as buying insurance coverage. Buying insurance coverage is not a panacea—there are deductibles, exclusions, conditions and warranties that can all impact how much risk is actually transferred. A “gap” in coverage can result in an unexpected, uninsured loss which ultimately shows up on the balance sheet of the unwitting organization. Real estate organizations have unique exposures to loss resulting from first party (damage to your property and premises) and third party (liability to others resulting from the organization’s negligence). Materiality of risk should be determined. Can the organization take a $5,000 loss but not a $500,000 loss? Knowing the risk you can afford to take will allow you to make clear decisions on how to structure risk transfer and to appreciate the cost of doing so.
“What Can I Do to Cover These Risks?”
Boards need to examine internal process and work closely with industry professionals to work through the risk management process. The objective is to arrive at the lowest “total cost of risk” (TCOR). Many boards have charters mandating that a periodic independent risk management audit (RMA) be conducted by a disinterested third party. We strongly encourage this approach, as an audit should provide the board with transparency on the current exposures and how their insurance and risk management program will respond. A properly conducted RMA should be commissioned no less than every 24 months, and be provisioned by an independent third party who is not a member of the board, does not write (or is a candidate to write) insurance coverage for the organization, and who will provide a report to serve as guidance for future board action.