Ceasefire Strategy | MyPage

SUMMARY ON CEASEFIRE STRATEGY

There has been a spate of massive Fire Loss incidents in the UAE’s industrial areas during the past over three years, with the loss values increasing each year.

This has become an Emerging Risk scenario in the UAE, especially, in respect of stock-based risks. If this trend continues, it will not take long to cripple the Insurance industry.

Premiums for these types of risks are absolutely incompatible with the inherent loss potential as against the past loss experience, mainly for the reasons that there are no credible market statistics for the industry as a whole, as also, unhealthy competition despite the fact that such types of risks are extremely loss-prone, with no industry level intervention to stabilize the results by bringing about a disciplined Rating structure.

Suggested methods include:

Emirates Insurance Association to form under its supervision and control a Common Risk Pool comprising of all the Member Insurers
Appointment of a Pricing Actuary to offer Actuarial assistance in order to obtain more accurate calculation of their Risk Exposure and to determine the “Pure cost of goods sold”
Geographical coding of the areas more prone to fire loss
Fixing of Standard Safe Tolerance Limit
Compilation of Market Statistics and build-up of industry level Statistical Data by the designated Third Party professionals appointed by the EIA
Evolving of a Standard Risk Rating System
EIA to assume the Role as a Friendly Market Regulator-cum-Supervisor and Facilitator on the model of Lloyds and ABI (Association of British Insurers)
Thereby, the Common Risk Pool will ensure that the Risks are properly rated commensurate with the level of fire hazard, its loss potentiality, frequency and severity, based on a proper Geographical Coding
Compulsory Self-co-participation to be imposed (up to certain percentage of the risk value) on the Insureds of predominantly stock-based risks, in order to make them partners in loss-sharing and thereby make them more careful
Grouping of UAE Insurers into a few Syndicates (for the purpose of Fire risk rating and sharing) in order to reduce the number of competitors into only a few, and these Syndicates to be regulated and supervised by the EIA to prevent unhealthy competition as well as to administer the Standard Risk Rating evolved by the Common Risk Pool

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THE NEED FOR A CEASEFIRE STRATEGY

IN THE WAKE OF

EMERGING FIRE RISKS IN UAE’s INDUSTRIAL AREAS

Introduction:

Going by what has been happening in the market recently it could well be said that not even water or rock would be spared from Fire loss in the UAE. Most of the industrial areas, especially in Sharjah and Dubai, have virtually turned out to be ash yards.

Unless the Insurers apply a circuit-breaker to the extremely overheated Warehouse and similar risks (which are nothing but virtual concentration camps of extra heavy Fire Loads and Fire Breeding centres) and define immediate ceasefire strategy, the industry will soon harvest in multitude the seeds of the sin it is sowing.

Fire incidents have now assumed the proportion of an epidemic and it is the duty of the UAE Insurance industry to stem the rot through strategic planning.

Presently, each Insurance Company works like a SOLE TRADER in isolation from the community as a whole, the only apparent motive being, amassing greater market share with expansionist ambitions, disregarding the profitability of the portfolios and the interests of the industry.

Fire peril as an Emerging Risks :

Emerging risks are either developing or already existing ones that are difficult to quantify and may have a severe loss potential
They are marked by high degree of uncertainty
Basic information which would help adequately assess the frequency and severity, is often lacking
Lacking of the systematic approach to Risk Management

Objectives in general:

To raise awareness among UAE Insurers of Emerging Risks in the UAE Industrial areas
Individual Insureds/ Corporate Insureds to participate in sharing the risk of such financial losses
Those who accumulate large stock values (which are easily susceptible to massive fire losses, like predominantly stock-based risks, warehouse etc.) in frequently fire-exposed areas shall be aware of the cost of risks involved and be made to participate financially in the risk through self-co-participation
The Insurance industry must minimize the surprises, if it has to continue playing its indispensable role in the country’s economic system
The need for qualitative exposure data of risks with regard to precise geographical coding, quality and age of building structures, etc. are very essential
UAE Insurers have to redefine their underwriting approach and seek Actuarial assistance in creating Models in order to obtain more accurate calculation of their Risk Exposure and to determine the “Pure cost of goods sold”, in a way that is more commensurate with the underlying risk
The need for an Actuarial intervention on UAE risks, especially for Fire risks in view of extreme volatility of the portfolio, unprecedented frequency and heavy severity.
The need to appoint or outsource this job to a professionally qualified and experienced Pricing Actuary by the Emirates Insurance Association (it can even be considered on a contract basis for a specific period) to assist the UAE Underwriters to arrive at the “pure cost of their products sold”. This is extremely essential to stop the present style of “whim and fancy Rating” or the “Dare-devil Underwriting style” by various Insurers, oblivious of the minimum underlying cost of the product they are selling.
Need for access to Civil Defense’s coding on locations, risks etc. for geographical coding purpose.

Specific objectives:

· Too much proliferation of Insurers and Brokers in a small market like UAE has in fact reversed a few of the Basic Principles of Insurance:

Ø the first principle reversed being “Pooling of resources of many to a Common Fund to indemnify the losses of a few”. The present greater number of Insurers have already overcrowded this small market, thus fragmenting the otherwise poolable Common Fund.

Ø The second principle reversed being “the operation of Law of Large Numbers”. With no Insurer in the market being in a position to enjoy a fairly large number of homogenous risks, no one is in a position to enjoy the advantage of “Law of Large numbers”.

Ø The third and the most vital element being the lack of meaningful and credible Market Statistics to work out appropriate Pricing for each class

Insurance doesn’t work well without proper Market Statistics and a combination of all the above three key elements have reduced the Insurance activities in UAE to nothing but Gambling.

The ideal remedy to counter the above anomalies appear to be in reversing the fragmentation into consolidation by forming a Common Risk Pool.

The Pricing :

When the prices of every commodity in the world is going up, the only one that doesn’t go up is the Insurance Price in an undisciplined market (even while the Claims in Value terms are increasing due to various reasons including the inflationary pressure). It is only in Insurance industry that not many local players do really follow the basics of pricing their products. Possible reasons could be no one really has in his possession the vital statistics to determine an appropriate pricing and even if it is there, cut-throat competition doesn’t make it sensible to him to compile the statistics to generate a credible Rating Strategy.

Keeping the above in mind a Standard Risk Rating System shall be adopted for Fire Insurance with a view to:

i) recoup the past losses and

ii) to stabilize the future results

Ceasefire Strategy – Key Steps:

· Formation of Common Risk Pool:

First step is to make a decision on the formulation of a Common Risk Pool (i.e. CRP)

· Appointment of a Pricing Actuary:

Appointment of a professional PRICING ACTUARY under the regulatory and supervisory control of the Emirates Insurance Association (EIA), representing the whole body of UAE Insurers (with permission, if needed, by their respective Reinsurers, in view that this is for the good of all, including the Reinsurers)

· Fixing of Standard Safe Tolerance Limit:

A standard Safe Tolerance Limit for Fire risks to be retained by a medium sized local Insurer, say, Dhs.3 Mio/Dhs.5 Mio or so (to be decided), has to be agreed among the member Insurers and any risk where the Sum Insured exceeds the Safe Tolerance Limit so fixed, has to be shared by the Pool members at self-sustainable sound rates (as fixed by the Pricing Actuary).

· Evolving of a Standard Risk Rating System:

It is the duty of the Pricing Actuary to fix the Standard Risk Rating system for various Fire risks depending upon the type of risks, geographical areas, past loss experience and the emerging nature of the risks in the forthcoming period.

· EIA to assume the Role as a Friendly Regulator-cum-Supervisor and Facilitator on the model of Lloyds and ABI(Association of British Insurers):

· The formation of Common Risk Pool (CRP) will ensure that the Risks are properly rated as per the standards stipulated by the CRP.

· Since any amount exceeding agreed Safe Tolerance Limit, say, Dhs. 3 Million / Dhs. 5 Million is ceded to the Common Risk Pool, that will give an opportunity to the CRP to enforce strictly the Rating System for the type of risks (i.e, in effect, the CRP/EIA will act as a Self-Regulator in the interests of its members). But this will work well only if the other members do not offer local Fac R/I support to such Risks by-passing the CRP norms.

· The CRP Member Company who introduces the business to the Pool will get his R/I commission up to a maximum of 25% (or to be decided), which the Other Member Companies who are willing to participate on the risk, have to pay the introducing Member Company. Maximum Brokerage to the Placing Brokers for such risks shall be restricted to 15% only irrespective of whether it is a renewal account or new one.

· This will give greater opportunity for the CRP Member Companies to enjoy the highly comfortable Rates and Terms, stabilize their results, reduce the level of cut-throat competitive Rates, inculcate a sense of self-discipline among the Members, offer increased Combined Capacity to the Market, increased R/I Commission rate to the introducing Member Company.

· Since the Rates and Basic terms are going to be common to all Members, administered by the CRP, the competition will be restricted to better services offered by each company and the resultant R/I Commission they can get from the participating CRP Members. This will cool off the otherwise overheated competition. Even the not-so-aggressive CRP Members can contribute their might as Capacity Providers at the same time automatically enjoying the fruits of their self-discipline through increased volume of business channeled through the CRP without burning their fingers, whilst the Members who introduce the business enjoy in addition to the increased volume of business, the Cool comforts of profitable rates and terms, increased R/I Commission on the business they are introducing.

· Those Members, who still do not want to approach CRP for Rate and terms approval despite the sum insured being in excess of the prescribed Tolerance Limit of say, Dhs. 5 Mio or so, shall not get local Fac R/I support from other CRP Members, leaving him with the choice of either approaching the international market for lower rates or retain full on his own account and suffer himself to the full extent when a loss occurs

· For small risks below the value range up to, say. Dhs.3 Mio/ 5 Mio or so, which are within the tolerance limit of each Member, there is no compulsion to cede such small risks into the Common Pool, thereby the system offers better flexibility and leeway for each Member as regards smaller risks.

· However, higher value risks exceeding the prescribed Tolerance Limit, requiring support, shall be rated and termed as per the CRP Guidelines, terms and Rates.

· Members of the CRP shall not be permitted to accept a Fac R/I offer for the above type of risks directly from a local leader (whether that Leader is a CRP Member or not), in order to ensure that all such risks are first offered to the CRP who will ensure that the Rates and terms offered are as per the CRP Guidelines and then it shall be the CRP who makes Fac R/I offers to the Member Companies on behalf of the Leader, who introduces the business to the Pool

· If any Member wants to offer any particular risk (with values lesser than the prescribed Tolerance Limit) to the CRP, they are at liberty to do so, but, at the Rates and terms as applicable as per the CRP Guidelines only

· CRP being formed out of mutual consensus of all the Members, it is up to each Member in deciding whether to participate on a particular risk or not.

· Formulation of a Standard Risk Rating Structure for the above kinds of risks with minimum Rate stipulation.

· Compulsory Self-participation of 15 to 20% by the Insured on Warehouse Risks which are not Sprinklered and such Warehouses which are over 10 year old.

This has to be actively discussed

The CRP doesn’t bear any risk on their own. In fact, they just facilitate a Consolidation, increased Combined Capacity, Self-discipline, Self-regulation,

compilation of vital Market Statistics, formation of Rates & terms and Market Guidelines, dissemination of key information to the members etc.

Grouping of Insurers into Syndicates:

Need for grouping of various Insurers into a few number of Syndicates (i.ro. of Fire risk purpose) to reverse the process of the current excessive fragmentation into consolidation
The Grouping of Insurers into a few Syndicates for various Fire Risks, may facilitate that Syndicate to arrange a “Per Risk XL Protection” to chop the peak value risks off its portfolio in order to stabilize an otherwise volatile Fire risks – may be on a “per risk”, “Catastrophe” and/or “Clash Cover” basis.

The need for a Research Wing to be created by the EIA for the UAE Insurance industry

Advantages in forming a CRP:

· By formation of a CRP, the market will soon regain the much-needed but long-denied CONSOLIDATION, thereby acting in unison as a single-minded body.

· The CRP will in effect be a consolidated venture by a group of like-minded Insurers who are prepared to contribute their capacity at their free will, without compromising on their own underwriting guidelines or Treaty restrictions, but at the same time it offers each member increased opportunity for the utilization of their idle capacity, bringing about a self-disciplined, fair market rate and terms, by which no one member loses but every one gains.

· With the formation of CRP, since most of the losses and the corresponding premiums of a large number of local insurers are recorded, it is easy to draw credible statistics over a wide-spectrum of risks thereby facilitating the Structuring of Rates for each category of risks based on its meaningful loss-experience, reviewable by the CRP periodically (say, Quarterly), so that any major loss in any Quarter or preceding Quarter can bring about a corresponding rate-hike immediately to stabilize the net results.

· Since the surplus risks are pooled to the CRP, the losses, if any, are shared by the participating members in the same proportion, thereby the impact of any loss is truly lightened as far as each member is concerned, as no member has to bear the brunt of any heavy loss on his own and suffer in silence.

Availability of Common Market Statistics allow for past experience-based Rating
Formation of CRP generates availability of increased Combined local Capacity thereby retaining more Premium income within the country and preventing the flight of foreign exchange out of UAE
Reduces cut-throat competition as well as undercutting of Rates.
Market becomes self-regulated, self-disciplined, responsible and above all transparent.
Our strong commitment to the above will ensure that no Member Company suffers any set back due to any heavy loss, but can even recoup what they have dearly lost in millions in the recent past – with their Treaty Statistics moving from Red to Green or green to greener

· The participation by any member to a particular risk is not compulsory, but will be at that Member’s free will and choice, leaving better flexibility for each member, without being fettered by any sort of compulsion.

· Rating Structure Guidelines formed by the CRP will be available to all the members and the quotations can be offered based on the basic minimum terms of the CRP Rating Structure Guidelines, subject to approval by the CRP on obtaining firm order.

· Member Companies will not lose his existing clients with this arrangement, unless his services have been poor, as, since the Rates quoted by different Members will be similar, what decides in favour of any one particular Member would be the customer loyalty he could command and the value of his services

· Those who are not members of the CRP will suffer, because they do not enjoy the increased Combined local Capacity available through CRP

· Since it will be unviable to check and audit whether an individual Member Company has violated the agreed Rates and terms, the Pooling into the CRP automatically ensures that what is ceded to the CRP is as per the CRP Rates and terms, thus ensuring full transparency, self-audit and self-regulation, which otherwise wouldn’t be possible or practicable at all

Some Rating thoughts:

· Warehouses, Labour camps and Factories which are pre-dominantly stock based risks shall be categorized and rated based on:

Ø Area Classification of the risk (as per the Fire hazard zone classification to be made)

Ø Whether the risk is a stand-alone, separate risk detached from more hazardous risk

Ø Whether the risk is a part of a row of warehouses or warehouse complexes or in the vicinity of another risk rateable higher

Ø The type of stock and contents

Ø A bare or empty warehouse building shall be rated at highest rate applicable to the hazardous stock that could possibly be kept inside by any of the tenants (unless warranted free of any kind of stock throughout the Policy period), as the building follows the fortunes of the stock or contents inside it and vice versa. There is no history of any Warehouse building or pre-dominantly stock based building remaining intact when the stock/contents inside that building is on fire

Ø Type of construction

Ø Age of the building (very old premises, unless renovated very recently as per the latest Civil Defence regulation shall be rejected for insurance by Age-Warranty stipulation (as is done in the case of Marine vessels for Cargo Insurance)

Ø Huge stock values accumulated in one single premises (this results in extra heavy Fire Load at the premises and the Stock itself turns out to be fuel for fire with no need for any supplementary fuel from outside the premises for a fire incident to rage its fury to the full )

Ø Application of SEVERITY LOADING FACTOR with the factor moving upwards with increase in the values by each million (higher the stock value in one single premises, higher the Severity Loading Factor). (This is for the reason that one single fire loss in such huge stock based premises is equal to a great many number of various separate fire losses in different smaller units over a period. Therefore, against the present wrong market practice (although due to market compulsion) of

offering Volume Discount on premium rate on huge stock accumulation risks, the rate shall in fact, be higher when the stock value in a single premises increases. The Quotations and the Policy shall be subject to Severity Loading Factor Table in order to thwart the move by cunning clients who might declare a low sum insured initially and later on increase the same step by step to circumvent the application of the Loading factor. This shall be applicable on Floating Policies as well with the maximum opted Floating Sum Insured being the criterion for the determination of the applicable Severity Loading Factor)

Ø Stock based premises above certain values shall be compulsorily insisted for Sprinkler installation, failing which, such risks shall be either rejected or the Rates shall be more than doubled to enforce installation of Sprinklers

Ø Building/Stock or any other part of the risk which is not detached by at least 10 meters distance in-between shall be rated at the same rate (without allowing any privileged rate for the building in variance from the stock it contains) applicable to the highest rateable material, allowance being given only as permissible in the Hazardous Goods Warranty

Ø The CRP Rates and terms shall be applicable even for renewal cases, irrespective of the fact that such risks at present might be enjoying an extremely low rate in their current Policy. To facilitate this process, periods of such existing Policies can be extended by a maximum of one month, within which period the CRP Rate and terms shall be advised to the client as the applicable renewal rate and terms. No other CRP Member Company shall be allowed to offer Rate and terms lower than the CRP Rates/Terms.

Conclusion:

i. If the above is generally acceptable, we all can work out the Formation of a Common Risk Pool and bring about a Standard Risk Rating Structure for those categories of risks requiring immediate remedial measures by appointment of a PRICING ACTUARY under the supervision and control of the Emirates Insurance Association.

ii) In order to make things easier, we can even think of outsourcing the job of collection/compilation of the Statistics etc., to an independent professional body like a THIRD PARTY ADMINISTRATOR or a professional Survey Firm

iii) Let us make a committed campaign for the accomplishment of the above strategy

iv) Let us be the DETERMINERS OF OUR OWN DESTINY in the best interests of the Insurance industry.

Authored by:

K.K.JAYARAJAN

TECHNICAL MANAGER, AL FUJAIRAH NATIONAL INSURANCE CO.,H.O. FUJAIRAH

The Author is:

FCII and Chartered Insurer of CII, London

CPCU – Chartered Property Casualty Underwriter of the American Institute of CPCU

FIII – Fellow of the Insurance Institute of India

ARe – Associate in Reinsurance of the Insurance Institute of America.