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How Changing Balance Sheets Affect Risk Appetites

Before the COVID-19 pandemic, companies already faced a problematic risk market in many respects. The global public health crisis and the economic impacts of the lockdowns have strained balance sheets more as business insurance premiums rise across the board and risk appetites evolve.

Companies are adjusting by reducing expenses through layoffs and pay cuts, cutting dividends and tapping straight into the debt markets. A rethinking of enterprise risk management is taking all these measures into account.

Risk professionals must navigate a pricing environment more challenging than the global financial crisis. The marketplace is focused on premium growth, and average rate changes are at their highest levels in a decade1. Amid the volatility, risk managers can take certain steps described below to help meet the demands of the moment and mitigate price increases.

Reassess Risk Appetite

The changing financial climate has compelled companies to examine how their strategic objectives roll up to their risk management processes. Companies need to assess the level of risk they are prepared to accept to achieve their strategic goals.

Risk appetite is the maximum amount of risk a company is willing to accept to achieve its strategic objectives. Quantifying the total amount an enterprise will put at risk to reach those goals can guide the organization's risk management processes. Having one number that encompasses all risk is not enough. Companies should create and use a consistent risk appetite framework to help managers balance opportunities with potential dangers.

Developing a risk management framework is not an easy task. Risk professionals will have to build consensus across the organization for how much risk the organization is willing to take. The chief financial officers and other senior leaders will have to reconcile the risk appetites they each have for their various business units and the enterprise overall. A comprehensive approach will consider operational as well as strategic risks.

Building a risk management framework will reveal the attitudes and approaches to risk across all parts of the enterprise. Some units will be riskier than others and may need separate coverages and protections. The idea is not to have a one-size-fits-all approach to risk management, but to consolidate coverages and protections when appropriate and evaluate risk holistically. The framework should set a clear link between objectives and risk management processes. Tools to monitor and report on risk, as well as operational metrics to track risk through the organization, will be needed to make the risk management framework an actionable part of the enterprise.

Take a Portfolio Approach to Insurance Programs

The volatile markets mean companies face more trade-offs when buying and maintaining insurance coverage. They must balance underprotection versus overprotection for their specific needs. The quantifiable numbers produced by the risk management framework will help companies strike the right balance of risk retention and transfer.

In the face of significant changes to the balance sheet, companies need to reexamine assumptions about their risk appetite, exposure to loss, and risk transfer program design. Insurance is placed one policy at a time, but a company must look at the portfolio of coverage to see the opportunities for savings and potential blindspots. Taking a portfolio approach to insurance coverage can help avoid expensive and redundant approaches to risk mitigation.

The portfolio approach to coverage allows companies to shift the amount of coverage among policies for better protection and to mitigate price increases. With this approach, a company may adjust its property coverage in exchange for more protection from cyberattacks, keeping the total amount paid for insurance the same while reducing its overall enterprise risk.

Analytics can help companies optimize their risk programs by measuring the volatility of their risk profiles and finding economically efficient insurance programs. By seeing the overall portfolio of protection, risk managers can adjust their programs to maximize cost efficiency.

Explore Options to Manage Adjusted Risk Appetites

A portfolio approach to insurance programs will allow risk managers to use several tools to mitigate the largest repricing of risk since the global financial crisis1. For example, premiums for directors-and-officers insurance have more than doubled from last year, causing companies to change deductibles or policy limits. Three main tools will help companies adjust to stronger pricing pressure in the marketplace:

  • Captive insurance, where the insurer is wholly owned by the insured, can be a useful tool to manage a portfolio of risk. Captives can allow companies to transfer or retain risk in a cost-effective way.
  • Catastrophe bonds transfer the risk of natural disasters from companies and their insurers to investors. The total investment in catastrophe bonds, which were introduced in 1996, and insurance-linked securities has surpassed $100 billion, and is expected to rise significantly this year2. The continued growth and diversification within the catastrophe bond investor base provide the capacity for more issuers to raise funds to transfer risk and reduce the cost of natural disasters.
  • Parametric insurance, which covers the probability of an event happening (such as a major hurricane) and pays out according to a predetermined schedule, can help companies reduce the cost of coverage. Parametric insurance can expand coverage for traditionally uninsured or uninsurable exposures and allow companies to quickly raise money in a catastrophe.

Prepare for Continued Volatility

The repricing of risk will affect all lines of business insurance coverage. The uncertainty has increased premiums, while many company balance sheets are severely strained. Enterprises will need to adjust their coverages accordingly.

Coming out of the pandemic, companies will require the capacity to make quicker risk decisions because the price of coverage is expected to continue to rise. A better understanding of risk can help organizations cope with the stress on their balance sheets while finding economically efficient insurance programs.

Risk appetites are specific to the organization. Enterprises need to consolidate risk, retain an acceptable amount of volatility and find comprehensive solutions that fit their needs. Companies can reformulate their risk management strategy while building long-term relationships with their insurers that enhance renewals, claims and pricing outcomes. A thoughtful process will bring peace of mind in uncertain times.


1 Aon, Quarterly D&O Pricing Index, Q1 2020

2 Reinsurance News, Total cat bond issuance surpasses $100bn: Aon Securities, January 2020