Just what makes a risk a good risk?
We need to understand risk quality does not mean hazards or loss potential a business is exposed to. Hazards and loss potential relate to what the risk does. For the most part, all businesses doing the same thing have the same hazards and loss potential.
Think about this concept for a moment. An interior carpenter has the same exposure to the same types of losses as any of their peers. For example, their employees are exposed to injuries from using power tools. It is a hazard they all have, and it has nothing to do with risk quality. In some states, residential carpentry contractors are exposed to construction defect claims. It is an exposure they all have without any true variance.
Risk quality relates more to the concept of the comparative likelihood of claim activity from one risk to another. Think about an example of the interior carpentry contractor. The likelihood of claims can vary significantly between peers. Contactor A may do a much better job at managing safety than contractor B. Contractor A may have a more effective hiring and orientation program which encourages employees to engage in task in a safer manner. Whereas Contractor B, may hiring anybody who seems halfway qualified and hands out the tools on their first day on the job without any orientation about how they expect the employee to do their job. One would expect Contractor B to have a greater likelihood to have claims than Contractor A.
Risks who are successful at managing their business are more likely to have good safety programs, quality control procedures and risk management practices mitigating the potential for losses to occur. The premise is things like safety, quality and good risk management are not stand-alone events. Rather, they are a by-product of successful management.
So, risk quality is less about hazards, exposures, and controls and more about how the quality of management impacts the likelihood of claim activity. It is about how well a risk manages their operations and executes their business strategy. While evaluating risk quality we look at.
We create an image of their ability to impact the loss potential of their operations whatever they are. Only when we have a clear picture of a commercial enterprise’s quality, can we begin to formulate a logical approach to successfully place or underwrite the risk for a fair and equitable pricing and coverage scheme.
Indicators of Risk Quality
Just how do we assess how management runs their business? What indicates they do a better job than their peers?
There is no one single piece of information telling us whether a risk presents average, below average, or above average quality. Rather, it is a multi-faceted review which paints a picture for us. Each information source enables the agent or underwriter to build more credible model. Each information source has its own strength and weakness.
It is also important to mention here, not all information sources are considered as carrying equal weight. Some sources carry a greater level of credibility or believability than others. This is particularly important when some information contradicts another.
There is a multitude of sources agents and underwriters can determine the quality of how well a risk is managed. As discussed in the prior section, some are more credible than others and should carry more weight than others when making the determination of a risk’s relative quality. But they all are useful to some degree in developing a representation of how good a risk is.
As an information source and quality indicator, financial statements are unmatched. Data included within the statements is highly accurate and can be used to confirm the accuracy of rating data. Furthermore, financial statements shed light on the ability to afford controlling hazards and exposures. Safety and quality control go hand in hand with finances. Making sure equipment is maintained and product is checked before selling does cost money. Review can help assure the client has the resources to continue with controls into the future.
In my opinion, financial strength is single best and most reliable indicator of risk quality. It is a simple formula.
Financial Strength = Good Management = Good Safety & Risk Management
In my underwriting career, I doubt I ever saw a company in strong financial condition disappoint me. Numbers do not lie. Businesses are strong financially because they manage every part of their operation effectively. That includes both safety and quality.
The United States Department of Transportation maintains a public (and free) database of the results of inspections performed on motor carriers and some other businesses operating trucks and tractor trailer rigs on the highways. SAFER uses carrier information from existing government motor carrier safety data bases. Presently, it consists of interstate carrier data and several states' intrastate data, and interstate vehicle registration data.
While used mostly for underwriting fleets, underwriting for risk quality transcends across individual lines of insurance. After all the whole idea of underwriting for risk quality is to ascertain how well a business manages its operation and executes on things like safety and quality. Therefore, data contained in Safer reports provides direct insights into the quality of management.
Better Business Bureau
The BBB was created as an organization to monitor and report marketplace activities to the public of local business entities. The primary mission of promoting and fostering ethical relationship between the public and businesses. The Better Business Bureau is dedicated to fostering fair and ethical business environment. After all, isn’t that part of what separates a good risk from a bad one?
For many smaller and uncomplicated risks, a good credit rating should suffice as an indicator of financial success and a poor credit rating may be an indicator of poor financial strength. It is important to understand “bill paying” is not actually a measure of true financial success or strength. Therefore, a good D&B or Experian rating may be used to imbue quality to small and uncomplicated commercial risk.
The internet provides underwriters with a plethora of information they can review about risks. Particularly commercial enterprises who deal directly with the public. In some cases, internet searches can reveal a vast amount information about their reputation in the marketplace. Sites like Yelp or Trip Advisors consumers can rate businesses and products. Even the electronic version of the yellow pages provides an opportunity to rate business.
It is important to keep in mind, there is a greater tendency to complain rather than praise. Therefore, there is a built-in bias toward negative ratings. These biases are more prevalent in some classes of risks. Some operations tend to bring out or elicit more negative responses.
Google Earth Images & Photographic Inspections
Like internet reviews, the internet provides underwriters with the ability to lay their eyes on almost any risk in the world. Depending on the location and the type of risk, images obtained from Google Maps or Google Earth can provide critical underwriting hard and accurate information about how well a risk is managed.
Quality Control & Safety Programs
If a risk has taken the time and gone through the exercise of formalizing their quality control procedures and safety procedures it is a good indicator of quality management.
Licensing Information or Trade Organizations
Some business operations require the business to be licensed by either state or local authorities. Many times, the database is available to all online such as contractors. Does this tell us the risk is professionally managed? Not necessarily, but an unlicensed business might not be as good as those who do go through licensing process.
Pulling it all together
As I discussed, sources can vary widely in terms of credibility and what they can convey about a commercial enterprise. Nor does any single indicator paint the entire picture of how a risk measures up in terms of risk quality in general terms or in terms of how they measure up against their peers.
Underwriters and agents need to take a much broader approach and weave information from the different sources into a single picture of risk quality. Like a jigsaw puzzle, a collection of information is woven together to form a more accurate picture of a risk. After each individual piece of the puzzle has been reviewed and evaluated, they need to be put together with other pieces. Sometimes, all the pieces point in the same direction, making the picture clear.
It becomes more difficult when some information conflicts with other information. Then agents and underwriters need to weigh the evidence for credibility and importance to the entire picture. Or perhaps conflicting data tempers the degree of confidence of the underwriter or agent’s decision. Hence, a more conservative rate and coverage offering may be a prudent avenue to follow. Regardless, even with conflicting data, the agent or underwriter has a clearer picture of relative risk quality having completed the exercise in evaluating risks for successful or quality management practices.