The market looks tough, says Martin South, but this is no time for brokers to ditch enterprise risk management. Make sure your clients know that

Although it has only just been made official, politicians, City traders, high-street shop owners and the man on the street have had no doubt for some time that the UK has entered a recession unlike any other in recent memory. And we’re not alone. The European Commission’s latest economic forecast makes grim reading – the eurozone economy is predicted to shrink by 1.9% this year and grow by only 0.4% in 2010, meaning recovery is still a long way off.

For this industry, tough economic conditions haven’t always been bad news. Historically, a hardening insurance market meant higher premiums and improving profits for insurers.

This time, a hardening market is set against the backdrop of staggering losses in the financial markets. Typical hard market attributes such as stock appreciation and greater access to capital are unlikely to be evident in the early stages.

And, as a result of the huge losses arising from the financial crisis, the value of insured exposures will fall this year, which will create what Brian Duperreault, chief executive of our parent company MMC, recently called “the invisible hard market”.

This invisible hard market represents a unique set of challenges in 2009, he explained. The positive effects for the industry will not be immediately apparent, nor will the instant gratification we have come to associate with rising premiums. It could well mean a better relationship between pricing and exposure, but this is unlikely to have an immediate impact on insurers’ underwriting income or their balance sheets.

Taking up this theme, I believe this invisible hard market will not remain invisible. When and how that change happens is unclear, but the signals for it might include the following: the green shoots of economic recovery leading to a rise in exposures; normalisation of investment income; or if we have a major insurable “event”.

So, how can the industry overcome the enormous challenges that lie ahead, while retaining its customer focus? To combat the slow improvements, insurers will become even more rigorous in underwriting risk and managing claims. For brokers, it will be vital to convey to clients the importance of good risk management as a mechanism to minimise risk and reduce the likelihood of claims.

As companies look to reduce their expenditure, it is all too easy to dismiss risk management as a “nice to have” but unnecessary corporate function that can be trimmed during tough times. After all, the notion of a chief risk officer having a seat at the boardroom table is still relatively new.

It is also easy for some commentators to blame the financial crisis in part on a failure of enterprise risk management. However, enterprise risk management did not fail, in many cases it was simply embedded incorrectly. Companies would be mistaken if they were to scale back or abandon any moves they have been taking on the proactive management of risk.

It is understandable that many struggle to understand how banks, the institutions generally credited with inventing the concept of enterprise risk management, made such disastrous miscalculations about the credit markets if they were properly managing risk.

However, good risk management is needed more than ever as the financial sector looks to learn the lessons of the recent past and rebuild its businesses. If clients believe otherwise, brokers need to actively explain and defend the benefits of true enterprise risk management.

Later this year, credit rating agency Standard & Poor’s is set to apply enterprise risk analysis to its non-financial corporate ratings. The agency believes that by adding this dimension, its rating opinions will be more forward-looking and create greater distinction among ratings, developing a more systematic framework for a highly subjective topic.

Marsh has been assisting clients with the criteria outlined in Standard & Poor’s requirements for more than a decade. Successfully integrating a risk management culture into an organisation can better facilitate resource allocation decisions, increase operational efficiency and company controls, and assist in compliance adherence. Like any other business management system, the key to success lies in its adoption and continuous development and improvement.

Brokers and risk consultants must play an important role in this process, helping clients to identify business-critical risks, audit existing risk management arrangements and aid in the construction and implementation of continuous, wide-ranging enterprise risk management processes. Enterprise risk management needs to be embraced and enhanced, not abandoned.

As insurance and risk experts, it is now the duty of the broker to support clients in these challenging times. Robust risk management supported by open, honest and transparent relationships are the key to everyone’s survival and long-term success.

Martin South is chief executive of Marsh UK