Ethical Underwriting – Part 4

I ended the previous post in this series by asking why there seems to be little direct evidence of ethical underwriting in the UK market. Is it just down to terminology or is it a jump too big to be contemplated?

Let’s consider each element in turn. I’m sure that underwriters do take management behaviours into account when rating commercial risks. This varies according to the line of business, with liability underwriters probably paying the most attention. This all goes under the generic title of moral hazard and is pretty well established across the market. It is however too general and high level to be labelled as ethical underwriting.

I believe the use by underwriters of indicators of how well a business is managing its ethical performance is rare, but I think it is likely to grow in use. It will become more structured and refined in lines of business where management behaviours are critical to the risks being covered (financial bond policies were given as one example). Some more general insurers will become early adopters and go on to tinker with integrating it into more mainstream commercial covers. I’d prefer to tweak the terminology here and refer to this hereonin as ethics rating factors.

This brings us to the ways in which ethical underwriting might try to emulate ethical investing. I mentioned in an earlier post that some insurers are already using their firm’s values to distance themselves from certain business sectors incompatible with those values. Here I’m proposing another tweak in the terminology, as this might more accurately be referred to as values-led underwriting. While insurers will always be seeking or avoiding business from this sector or that, I think there are several who are doing so based on a clear set of corporate values.

What we referred to in the previous post as positive ethical underwriting (for example, offering better terms for renewable energy compared with coal fired energy) is I believe rare to the point of non-existent. Underwriters are going to remain focussed on the mechanics of the risk, not its social, environmental or ethical credentials. Unless someone can establish links between those credentials and the loss patterns that go with them, this isn’t going to go further than the drawing board. That said, if it does emerge, it’s likely to be around liability covers as class actions challenging certain business impacts gain momentum.

Let’s go back to values-led underwriting for a moment. Let’s assume that a growing number of insurers begin to see, say, arms manufacturing as a sector they don’t want to be involved with. The market capacity available to that sector will then diminish, leading to an increase in premium rates and resulting in what would in effect be an ethical loading on the premiums arms manufacturers have to pay. The problem here is the market cycle and the likelihood that those premium rises will draw in capital seeking higher returns, whereupon the market softens as a result. It could be two steps forward, one step back.

So to sum up. Several forms of what I started out calling ethical underwriting do exist, but can be more accurately described as the traditional moral hazard approach, ethics rating factors and values-led underwriting.

All said and done?  Not at all, for what we’ve been talking about in these four posts is the use of ethics in underwriting. What we have not touched upon is how an underwriter should underwrite ethically. In other words, what practices should an underwriter follow to ensure that they carry out their responsibilities in an ethical manner. So in a subsequent post (or two), I’ll explore this other side of the ethical underwriting coin. What ethical responsibilities do underwriters have and how should they best exercise them?