Bankers, Insurance and Umbrellas
“A Banker Lends You His Umbrella When It’s Sunny and Wants It Back When It Rains”
If the only malady affecting this quote were a wrong or doubtful attribution to Mark Twain, I would have felt alright. Slighted — no doubt, but in this age of memes, some degree of reluctant acceptance to half-truths is natural and almost expected.
My gripe with this quote is around being singled out as a Banker. If you know your committed from your uncommitted facilities and read the reams of legal documents when you signed them, then you understand that your Bank/ Bankers asked you not to be too adventurous in monsoon!
It seems that our clever but richer cousins on credit insurance (insurance from here on) side were either a breed not known to the author of the quote or their business not as large or widespread then as it is today.
To paraphrase this quote to suit the insurance context:
“An Insurance Promises to Provide You an Umbrella When It Rains IF
- It doesn’t rain too lightly AND It doesn’t rain too heavily (Non qualifying Loss and Maximum Liability)
- You stepped out without knowing it was going to Rain (Loss Minimization)
- You promised not to wear a raincoat in case insurers had also agreed to provide you an umbrella
As and when such an umbrella is provided, it may (depending on the terms of the contract)
- Only open once you have had requisite and pre-agreed amount of rainfall soak you (Aggregate First Loss/ AFL or Excess of Loss)
- Only stop 90% of the rain from there on i.e. At least 10% (or some such pre-agreed percentage) of your body continues to enjoy the raindrops
- Fold back — thereby denying all protection — in several clauses that you often see on the 2nd read of the document!”
Stretching this analysis further, one could even argue that insurers are not in the business of selling umbrellas but selling desiccants and that too after a certain amount of time has passed (Waiting Period) and to that extent they do not help provide cover from rain but help with partial drying post fact.
The unfair and simplistic take on insurance above notwithstanding, the number of times sophisticated actors have misunderstood insurance and its usage is worryingly high. In contrast to other risk mitigants (guarantees, CDS), an insurance contract is not unconditional i.e. a mere occurrence of loss which triggers payment under other instruments is necessary but not sufficient for an insurance contract to pay. It’s also not comprehensive i.e. not all losses are covered.
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A good starting point is to assess what you get for your money when you buy an insurance policy. Assuming your potential losses were represented by the rectangle below, then insurance covers the smaller rectangle labelled “Insurance covered”. The widths and size of the respective rectangles may vary depending on the specific case but its important to note and understand the presence of these other boxes.
The second but equally important point is that the size of the vertical, dark gray rectangle (“Exclusions”) can easily cover the entire rectangle if not managed well. The triggers for this could be as simple as non-payment of premium or a failed declaration but can also frustratingly extend to things well outside the insured’s control — for example a buyer raising a dispute intentionally closer to due date (A dispute, dear reader, is a straight exclusion).
Buying insurance puts additional operational burden on the insured of putting up processes around timely premium payment, declarations, overdue and adverse information intimation to the insurer as any lapses here can have significant costs in the form of claim rejections. Marsh, the bellwether of all things broking in the insurance world, have published this analysis which lists the most common reasons for rejection of trade credit claims. I have reproduced a few reasons here from this piece of work which demonstrate the additional reporting or monitoring expected from any insured if they rely on insurance as a risk mitigant:
- Failure or late reporting of an account which has breached reporting requirements/the maximum extension period (MEP)
- Credit limit issues — lack of justification/no credit limit
- Delivery of goods after the MEP/stop shipment has expired and/or applied
- Failure to submit the claim within the submission deadline.
- Cover obtained on the wrong entity
- Contractual terms of sale greater than those endorsed to the policy
- Failure to obtain satisfactory proof of debt/confirmation of debt
- Failure to raise invoices within the required period
In the same note, Marsh advise insured entities that carefully following your policy terms and conditions will help ensure that all of your claims are settled promptly and in full.
In summary, buying insurance helps mitigate credit risk and introduces operational processes (and therefore operational risk). Implementation of robust processes mitigates these risks and makes sure the insured don’t trip on a particular reporting or contractual requirement and keep the same dark gray rectangle in check.
Finally, AFL (and Retained Risk) are a function of the risk you offer the insurers and the pricing you seek from them. Increase in sizes of these Red and Purple rectangles should have a direct bearing on lowering of risk pricing and vice versa. Insurers operate on the principle of skin-in-the-game so the chances of getting a policy without any loss sharing (in whatever form) are only slightly worse than getting Mark Twain to own the quote at the top of this page.
There is another popular quote which goes something like this — The banker who sanctions your loan is not the same person who comes to collect it. I wonder if there is a related quote that connects frontline staff and the claims staff at the insurance company. I won’t be surprised if there are parallels!
