The timeless maxim- “think globally, act locally” – coined in 1915 by social activist Patrick Geddes, underscores the vital importance for insurance agents to really think through the scope of their engagements with clients. The tide of recent events – from spreading political instability in the Middle East and Africa to the multiple tragedies that have befallen Japan – present new challenges.
The world is interconnected today – economically, socially, politically, technologically, and in other ways that pose unique challenges to professionals in the insurance industry charged with understanding and responding to such risks. A highly improbable but extremely consequential event – a Black Swan – that occurs thousands of miles away can spring into motion a startling series of dismal business, operating and financial risks for even the smallest of companies. Even if these events only have a ripple effect on individuals and businesses, each one presents a new kind of error and omission (E&O) risk for insurance agents who offer risk management services to their clients.
These agents identify, assess, quantify and prioritize such risks for clients, no matter how improbable. The onus, therefore, is on these professionals to learn all they can about these risk scenarios, extrapolate their fallout for each client, and recommend the appropriate level of insurance to protect the clients’ assets. The alternative is to do nothing, which, depending on the scope of the engagement with the client may be just fine, as long as this limited scope is clearly documented. Otherwise, it may be an invitation to a possible E&O lawsuit.
Many clients depend on their insurance brokers and agents to handle risk management as part of the transactional relationship. Agents often encourage this reliance by marketing their knowledge and experience to win and retain client business. As such, they must be careful: A loss deriving from a client risk that should have been identified and properly insured will come home to roost as a potentially costly E&O liability for the agency or brokerage.
Discern, Define, Document
Often, the best way to assess the potential impact of a natural or man-made disaster is through scenario testing – a “what if” question followed by the possible outcomes for the client. For example, an agent or broker wearing the hat of a risk manager who understands that a client does business in Mexico will need to research or imagine various risk scenarios and then test the possible outcomes to determine the appropriate level of coverage.
One such scenario is the pronounced risk of kidnap and ransom schemes in the country. Another is the possibility that the government of either country could close the border between the United States and Mexico because of increased drug trafficking. Last year in Ciudad Juarez, the center of Mexico’s drug cartel wars, more than 3,000 people were killed. A border closing would have a devastating impact on the supply chain of a company either manufacturing in Mexico or otherwise drawing upon low-cost Mexican labor for parts.
By presenting these possibilities to the client and, most importantly, documenting this presentation, an intermediary has performed effectively, illuminating the potential consequences of an improbable event, while appreciably reducing the prospect of E&O litigation against the firm.
Obviously, it is impossible to identify every possible risk scenario. A key element in documenting the services provided is acknowledging the services that are not provided. Even if an agent or broker is engaged to provide a relatively full spectrum of risk management and insurance coverage, it is critical to document in writing that the service does not warrant or guarantee elimination of uninsured or underinsured risk.
Connecting the Dots
Agents often must walk a perpetual tightrope between predicting worst-case scenarios for clients and managing their own risks via proper disclosure of provided services.
Consider the herd of Black Swans that have plunged from the blue in recent years – a devastating oil spill in the Gulf of Mexico, a volcanic ash cloud in Europe, Hurricane Katrina, massive floods in Australia, the global financial crisis and recession, increasingly burdensome and punitive regulations, disturbing inflationary pressures in India and China, and the aforementioned earthquakes, to name a few. Each event presented significant physical, emotional and financial consequences for people and companies around the world, from higher energy costs to severe interruptions in supply chains and the smooth flow of commerce.
One might argue that many of the aforementioned events don’t fit the mold of the Black Swan, particularly the one popularized by Nassim Nicholas Taleb in his 2007 book “The Black Swan.” How improbable, after all, is a hurricane in the gulf coast or an earthquake in Japan? But, as the Insurance Journal online edition recently pointed out, the Magnitude 9.0 earthquake in Japan was a “stark reminder” that powerful seismic events can also happen in the United States. Yet, the fact remains that many homeowners and businesses in California lack earthquake insurance.
According to the IJ article, most California residents live within 30 miles of a major fault, yet only 12 percent have earthquake coverage – a sobering statistic with potentially far reaching consequences for agents and clients, and a reminder of the uphill battle the agent faces in preparing clients for such events. What makes these events improbable is not the inability to predict them, but the pervasive impulse to believe they “won’t happen to me.”
This is not to say that intermediaries must have the skills and resources to predict things like the ousting of Egypt’s president in a people’s putsch, or the triple horrors of the earthquake, tsunami and nuclear release issues pummeling Japan. It is arguably, however, the role of brokers and intermediaries to assist in closing their client’s knowledge gap.
Opportunities and Drawbacks
Needless to say, the agent or broker who identifies, introduces and illustrates new potential risk scenarios to a client is in an opportune position to market related insurance protection, assuming it exists, or to advise increases in coverage limits. But there is a caveat to all of this.
The particular drawback to managing client risk is not truly having the expertise to effectively do it.
During the recession, in an understandable effort to increase revenue at a time when commission income had precipitously fallen and the property/casualty insurance market had continued its six year softening trend, some intermediaries broadened the scope of their services. Not all of them, however, were positioned to adequately handle risk management – not that this necessarily stopped them.
The message here is simple – if you don’t have risk management expertise don’t pretend you do. It’s a recipe for disaster.
The many agents that do have this ability and experience should consider enhancing it continually through courses and seminars, reading the trade periodicals, and following the best practices of corporate risk managers.
Black Swans are seemingly everywhere these days. What is global has indeed become local. The time for agents who offer risk management services to confer with their clients about how these kinds of risks can affect their businesses is now.
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