Ethical Underwriting – Part 3

The previous two posts in this series about ethical underwriting looked at moral hazard and the use of ethical indicators when underwriting. All very well, but with what aim in mind? Clearly to become better at differentiating between good and bad risks, with the ultimate purpose of producing a better underwriting return and an increased market share. In other words, a better financial performance for the insurer.

That is a pretty good purpose in its own right, but in ethical terms, is it enough? If more could be done, what would be the purpose in doing more? That’s something that individual insurers should decide for themselves. Needless to say, what any one insurer does do should be consistent with its overall business strategy and in particular with any existing ethical dimension of that strategy.

Let’s assume that the insurer does have ‘behaving ethically’ as part of its business strategy. How then should its underwriting function fit in with this, beyond the moral hazard and use of ethical indicators outlined in previous posts? Remember that insurers sit on vast piles of money as premiums are collected before claims are paid out. That money is invested and it is not uncommon for insurers to apply some version of an ethical investment mandate to it.

An insurer working with an ethical investment mandate would be avoiding certain defined sectors (such as arms, pornography and alcohol) and engaging strongly with other sectors (such as power and transport) in order to improve their environmental, social and/or ethical performance. In these circumstances, it would be logical for that insurer’s underwriting arm to follow a similar approach of exclusion and engagement. In other words, avoid insuring business sectors inconsistent with its wider ethical approach and offering terms on business sectors designed to encourage improvements to their, say, environmental performance.

So if the investment arm was not investing in arms manufacturers, then the underwriting arm should act likewise. If the investment arm was engaging strongly with a power company with significant coal based power production, then the underwriting arm should do likewise, by for example, offering more competitive terms to cover that company’s renewable energy production.

Such a sector based approach to underwriting would be easy for an insurer to implement, for business sector is one of the principal factors taken into account when rating a risk. It is  already much used to attract and avoid insurance business from particular sectors.

Might this dimension of ethical underwriting be already in use? The signs are mixed. Earlier this year, the media was talking about “the first ever ethical insurance policy”, but that simply meant the insurer was applying an ethical investment mandate to the assets underpinning its general insurance business. An ethical insurance policy would really only be worth its salt if it had been underwritten according to an ethical underwriting mandate, not just an ethical investment mandate.

It does however seem unlikely that insurers like Ecclesiastical or Cooperative are going to be going on risk for arms manufacturers, even if only for a tiny sliver of their cover. I hope they’ve checked on that though!

Ecclesiastical certainly has a highly visible commitment to seeking business from sectors in line with its origins and the values of its owners. Yet companies like these tend to display surprising little direct evidence of ethical underwriting as outlined above. Why haven’t they? Is this just a matter of terminology, or is that jump, from ethical investing to ethical underwriting, just not on anyone’s radar so far? If not, why not? That’s what I’ll look at in  the next post.