Navigating the Ambiguity: Insights into Determining Insurance Coverage

I am going to pose a question, and as much as it may frustrate the reader, I am not going to provide an answer – that is your job.

How much insurance should I have? (substitute 'I' with 'my business' or 'the company I work for'). Note that I haven’t posed the question as: ‘How much insurance do I need?’

This is such a difficult question for someone like myself, an employee of an insured entity. A broker or an underwriter can reel off a myriad of reasons why our cover should be this much or that much, but what is the reality?

Of course, I am only talking about professional lines cover – professional indemnity, directors and officers' cover, or even fraud (Crime). General lines are relatively easy to determine because, for the most part, they are based on tangible costs, i.e., rent costs, asset costs, etc. And for public liability, actuaries have ‘worked out’ the value of permanent injury or death. It is the intangibles that are hard to pin down. 

In their contract negotiations with us, clients will try to dictate exactly how much cover we should hold just to make them feel comfortable. But how have they put a value on their level of comfort? A picture comes to mind of a person standing in a field, licking their finger and holding it up in an attempt to determine from which direction the wind is blowing. What is the 'vibe'? Is it $X or $Y? Who is to say?

Some clients leave it to our discretion, with language along the lines of ‘The Manager has, and will maintain during the currency of this agreement, professional indemnity insurance with a reputable insurance carrier in amounts and for coverage as is reasonably acceptable for the business in question.’  In leaving it to our discretion, though, they are not really being very helpful. They are leaving it to us to decide what is adequate.

So, how much insurance should I have? Am I insuring for my actual risks, or am I insuring to meet the perceptions of my client base? And which is more important? Given that limits under the latter would arguably be greater than under the former, it raises the territorial question of whether we should let our clients dictate our insurance level. From a pragmatic perspective, the argument is that if we want that client, we will endeavor to comply with their wishes.

So, in trying to remove the guesswork, the question we must ask ourselves is, where do our risks lie?

 However, perceptions go a lot wider than just our client base (although they are never entirely removed from the equation). As background, my employer is not a small player in our industry, and no matter where you go in many parts of the world, you will not be far from an entity that we will have some relationship with, be that as an owner or a lender. As a global organization, then, what is ‘reasonably acceptable for the business in question?’  Is it a factor of funds under management (FUM)? What is appropriate for, say, a $50bn FUM? What is appropriate for a $200bn FUM? What would our regulators expect to see? What would our assets expect to see? What would our ultimate owners expect to see?

Let us move away from the perception aspect and back to the fundamental purpose of insurance. In simple terms, it is all about transferring risk. Paying a (relatively) small fee now to avoid a large loss which may or may not happen later. 

So, in trying to remove the guesswork, the question we must ask ourselves is, where do our risks lie? Our firm's risk taxonomy is quite broad, reflecting our industry's complexity and the depth of our operations. Essentially, however, our thinking is guided by asking: what risks, if they occur, will cost us money? Is it unit pricing? Or a breakdown in controls such that we miss deadlines? (e.g., buybacks) A breach of a regulatory obligation results in fines for the company or our directors/officers. And what might those risk events financially translate to? Is it thousands of dollars? Is it in the millions? How long should we draw a bow when making our estimates? What is the likelihood of a catastrophic event which might cost tens of millions? Are we prepared to take that risk?

With such questions, it is difficult to be objective in the Professional Lines space. Subjectivity breeds conservatism, and thus, limits creep up. Oddly enough, some objectivity does sneak in as the limits increase. Large limits are typically layered, and the higher the layer, the less the premium, so, hey, why not add another $20mn on top, given it's not going to cost that much more? While the likelihood of a claim in this realm is low, the clients, for the most part, are happy.

Now, don’t get me started on deductibles