Vacant premises, company cutbacks, rising crime - risk factors in a recession are very different from those in a boom. Steve Coates reports on how underwriters must adjust to hard times
The last technical recession in the UK occurred in 1991 and while this resulted in some significant economic hardship, it was relatively short-lived and recovery was swift. Many economic commentators consider the most likely comparator for the recession we now face to be the early 1980s, when the UK experienced a prolonged and severe recession accompanied by mass unemployment and financial hardship. So we are looking back either 17 years, when many underwriters might not have been in the industry, or 27 - when the majority of underwriters will probably not have been around.
This presents the industry with a significant challenge. Given the unprecedented prosperity we have all experienced in the past 10 years, how can we ensure our underwriters are aware of the real effects of a recession and how underwriting behaviour should be shaped to counteract such effects? Many underwriters will either be unaware or may have forgotten the economic and sociological changes a recession brings and so those of us who have been through such hard times need to educate our colleagues. Yet what are the principal effects on the insurance industry?
First, we must expect a rise in crime and a look at the police recorded crime statistics gives an indicator of one of the challenges we face. Between 1995 and 2007, burglaries reduced by 59%, vehicle thefts by 66% and vandalism by 20%. Consequently, underwriters have become accustomed to risks being subject to a lower level of crime. However, the Home Office's latest figures, for the three months to September 2008, indicate a 7% increase in burglaries and 16% rise in fraud and forgery, representing a significant challenge to underwriters.
The insurance industry had already seen a prelude to this with the recent increase in thefts of building fabric (lead, copper piping, slates, electric cabling and so on) precipitated by the boom in commodity prices. As times become hard, we can expect criminals to find a way through some of the improved building and vehicle security installed in recent times. Thus it will be important for security to continue to be reflective not only of the area and the nature of goods within premises, but also the prevailing economic climate.
Arson is likely to be a particular problem. In March this year, the Association of British Insurers warned that incidents of arson tend to increase during an economic downturn, and insurers were already reporting a jump in large-scale fires that cost more than £500,000. The cost of fire damage rose to a new high during 2008; damage to homes cost £408m during the year - 17% more than in 2007 - while the cost of damage to commercial premises rose by 15% to £865m.
During the last recession, the ABI saw a significant increase in arson, prompting the government to set up the Arson Prevention Bureau. Arson trends remain stubbornly high and the APB reports that deliberately set fires already cost the economy £53m a week in England and Wales. It also says that about 45% of non-domestic fires are thought to be deliberately set.
So insurers must expect an increased incidence of arson claims - genuine and fraudulent. For property underwriters this is a particular concern because many large fires in recent times have been caused (or were in all likelihood caused) by arsonists (see p25). It is vital that underwriters and insurance surveyors' assessments of security focuses as much on the risk of arson as that of theft. Underwriters accepting unalarmed and unattended premises do so at their peril. Multi-seat fires are much easier to ignite when the arsonist does not have the worry of an alarm to deal with and, by their nature, such fires tend to be more destructive.
Recessions also bring wider problems for society and the insurance industry to address. There are businesses that despite being able to survive, do so under financial stress. To continue trading they must cut costs, lay off staff, shut premises and achieve lower margins. This presents a different insurance risk and underwriters must be alive to the ramifications of any changes. Clients may cut back on maintenance or training and this sometimes means buildings are more prone to damage, machines more dangerous to users or likely to cause an electrical fire, and employees who are less aware of the dangers of the workplace. Health and safety can be perceived as an all-too-easy target for cutbacks.
One of the most noticeable symptoms of a recession is vacant buildings. As companies either go out of business or curtail their operations, some of the premises they formerly occupied may no longer be required and the likelihood of the premises being re-let or sold is dramatically reduced. Unoccupied buildings are proven to be a target for arson attacks, especially when security is weak or the premises are not visited regularly to check for damage or entry. If insurers agree to continue cover, appropriate security measures must be adopted and this may include alarms, boarding up or security guards.
One change that will affect fires in vacant buildings is the recent reform of the fire and rescue service. From now on, where buildings are known to be vacant, fires are likely to be fought less aggressively than before. This will frequently mean damage to the building is more severe. Construction sites can be vulnerable when work is mothballed and the site left vacant for months at a time, especially if a part-completed building is then left with incomplete security or exposed combustible materials.
If insurers are to successfully navigate their way through the recession, it is vital their underwriters are aware of all these issues and understand the implications. Clearly, there are still many underwriters within the industry who can recall the early 1980s and who will have an idea of what might change. For those who are new or have only written business in prosperous times, the solution must be training and building an awareness of the risks a recession presents. How did crime look in the early 1980s? If the trend is repeated what might happen now? Many insurers are already considering how to educate their newer staff and this will be essential if the effects of recession are to be contained.
- Steve Coates is head of property and casualty at Allianz Commercial.
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