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.
The RMA should consist of several key parts:
1.) A survey of the physical property, including a replacement cost construction appraisal using a recognized valuation service.
2.) A review of the operational practices of the organization, including how they manage contractors and commercial tenants, and what risks could come from these areas.
3.) The third area to consider is the insurance coverage that is currently in place. Does the coverage include all the components that the organization should have and is the coverage scope of each as competitive as possible? The RMA should outline if the support services from the broker or claim administrator are effective. What are the service expectations of your insurance industry service providers?
The RMA should also make particular note of exposures that are not included in the insurance policy scope and which the organization may want to consider. Typical examples of this are environmental coverage, discrimination coverage, rebuilding to code (which is excluded in “normal” property policies). These are the “gaps” that make the organization responsible, knowingly or unknowingly, for the financial impact of a loss. The RMA can then be presented to the board and include an action plan for how to manage those exposures that have been identified, and renewal strategies for the coverage.
The insurance industry has become very clever with policy terms that obligate the policyholder to do certain things—obtaining certificates from contractors, for instance—or risk voiding their coverage. Imagine thinking you have coverage, only to learn there is a condition that you haven’t complied with, and your policy is worthless. “If I only had known” is not much solace when faced with a million-dollar claim that is being denied by your carrier. Today, an insured must take the time to understand the process and how his or her coverage works. Take the steps to make informed business and risk management decisions and you will reduce the amount of unpleasant surprises you get from the process.
Albert L. Sica is managing principal with ALS-UIC, a risk management consulting group in Upper Saddle River, New Jersey.