Financial benefits of insurance misunderstood at board level

Insurance is seen as a commodity purchase that warrants little boardroom attention, rather than a financing tool that is, in reality, as important as debt or equity, according to experts at consulting group Mactavish. The group said that risk managers need to change this perception by expressing the benefits of insurance in the same financial terms as other means of debt structuring.

While the level of corporate attention given to a bond or stock issuance is typically high, there is little focus on the purchase of insurance. This is despite the fact that it is a more complex arrangement. Instead, insurance is seen as a necessary evil and a commodity purchase more akin to buying a new fleet of company vans than arranging finance, said Mactavish experts. One of the reasons for this disparity, said Rob Smart, director of research at Mactavish, is the lack of analytical frameworks to express insurance in the same accounting terms as other financing instruments.

To address this shortfall, Mactavish has developed its Insurance Materiality Analysis (IMA) tool that enables risk managers to benchmark certain insurance policies against other financing elements in the business.

The IMA requires input from a company’s financial reports (profit and loss account/balance sheet/cash flow statements) and its insurance programmes (coverage/premiums/limits/ retentions/deductibles).

The inputs can then be mapped against a number of indicators such as maintenance cost, cash availability, earnings and premium cost to ascertain the impact of policy failure, the ease of raising new debt, the materiality of spend and, ultimately, the relative value offered by insurance against other financing arrangements.

Some risk managers may have to be wary of what they wish for though. There are a number of questions that follow from adopting IMA and attracting greater attention from senior executives, many of which could prove difficult for an unprepared risk manager.

As Smart said: “It is a great opportunity for a high quality risk manager to show the value that they are adding through the development of bespoke insurance, stress-tests around non-payment scenarios and other efforts to reduce the possibility of policy failures, but much of this work does mean disclosing that insurance will not always pay out as expected and there is sometimes a certain reticence to do that.”

There may also be some reticence among risk managers to bring insurance purchase too far into the realm of the finance division in fear of losing ownership of the process to a chief financial officer or finance director. However, said Smart, any of these fears should be outweighed by the opportunity of greater engagement with the board.