Aligned interests

When overcapacity in shipping pushes down the value of older vessels, marine insurers tend to worry about the implications for moral hazard. Do the owners of those ships have the same motivation to protect the vessels from suffering damage or loss?

These days we are nearing the trough of the effects of overcapacity and reduced shipping. Through several such cycles it was assumed that any marine underwriter with any sense should be raising hull rates substantially—unless the owners were participating in the risks in a captive, or were part of a shipowners’ mutual.

Commentators back then went so far as to advise marine insurance underwriters to refuse to renew large hull accounts that do not take a significant share of the risk in a captive insurance company, because of the increased moral hazard.

The principle should have spread to large but aging concentrations of property values, as well as the liability exposures on aging fleets of long-haul trucking companies. Commercial insurers constantly face that issue of moral hazard, where the insured cuts down on maintenance and allows the risk of total loss to increase, although it is not a subject that is much discussed in renewal negotiations.

In fact, a large deductible arguably provides the same comfort in reducing the suspicion of moral hazard. In this instance the insureds are participating in the risks. There is a big difference between the non-insurance decision to take on a high deductible and the self-insurance decision to take the risk in a captive insurance company. Note the different terminology: the difference between non-insurance and self-insurance.

Risk management
Insureds with many locations, or entities with many risk units that practise non-insurance in the form of deductibles imposed on operating entities, leave it up to local management to look after moral hazard and the attendant losses that could follow.

One issue with high deductible programmes is that the information and knowledge of smaller losses is no longer available, since local management has no financial interest in reporting that information. Does that create an incentive to maintain risk management at a high level? Experience has shown that it often doesn’t.

It’s not the same as the centrally-financed (in a captive) programme of self-insurance in which losses and even increased risk situations are managed by a central service. In such instances some of the moral hazard associated with the higher risk of aging facilities is overseen by a central service that has an interest in preventing the kinds of claims that will weaken a captive’s balance sheet.

The availability of risk and loss information required from operating companies makes the central risk management and risk financing service more relevant to reducing that kind of moral hazard.

In this age of reduced confidence in general, and reduced confidence in the insurance sector in particular, that aging advice offered to the marine insurers could well become part of the strategy of multinational insurance networks and their multinational clients.

The same logic applies in the captive insurance industry. Accounts with a well-funded and well-managed captive insurance company have minimal concerns around moral hazard. The requirement of insureds to be participating in a captive insurance arrangement should be part of the modern renewal strategy.

Hugh Rosenbaum is the founder of the consultancy Hughro. He can be contacted at:  hughro2@gmail.com