Beware the dangers, warns Sush Amar, of relying on insurance without managing your underlying risks.

The world is a strange place these days. Businesses have spent the last two years building up their capital levels, but uncertainty about future growth means they often can’t find anything worth investing in. Charities, of course, are facing a much bleaker funding future with many dipping increasingly into their reserves to make ends meet.

But while charities may be casting envious eyes at commercial balance sheets, capital alone is no guarantee of security. Recent surveys suggest both the private and voluntary sectors need to better reflect their actual risks when seeking ways to protect their operations.

Lloyd’s risk index

In 2009, the insurer Lloyd’s commissioned the Economist Intelligence Unit to survey over 500 global business leaders on their priority risks and, crucially, how well prepared they felt to tackle them. Late last year, Lloyd’s published its second report on the subject – the Lloyd’s Risk Index 2011.

At the height of the 2009 credit crunch, the top three risks listed by business leaders were direct responses to the liquidity crisis. They were: the availability of credit, currency fluctuation and insolvency risk.

Two years later all this has changed. As governments, industries and consumers cut back, the top global risk identified in 2011 was a business fundamental – the loss of customers and orders. At number two, despite rising global unemployment, was the risk of talent shortages. Interestingly, business leaders felt more than adequately prepared to deal with the first risk, but under-prepared for the second.

But what actually defined 2011 in reality? It was a year dominated by natural catastrophes, abrupt regime change and the European sovereign debt crisis. From an insurance perspective these are high-impact events.

Yet these risks were not reflected in business leaders’ responses. Sovereign debt came in at number 27 out of 50 risks, abrupt regime change came 45th and flooding and earthquakes were both in the bottom ten. And in a year of unprecedented cyber attacks, cyber risk only made number 12.

For all but two of these 50 risks, businesses felt their level of preparedness was greater than the risk itself.

Were these risks given a lower priority simply because they are insurable risks? If so, reality offers a check for those who rely on insurance without combining it with risk management measures. Current estimates of the economic costs of the devastating Thai floods, for example, are around $45bn. Only $20bn of this is insured.

As going-concerns in a fragile world economy, businesses need to ask themselves if their approach is sustainable. Are they really prepared, or do they just think they are?

Are charities any more realistic? The results of the first Charity Finance Charity Insurance Survey, may suggest otherwise.

First, the greatest source of dissatisfaction charities have with their insurers is the quality of the risk management advice offered. Second, cost is more important than the available range of relevant cover and their insurer’s knowledge of their work. Third, a fifth of charities review their insurance arrangements less than once every three years.

No-one is suggesting that charities should suddenly magic up new funds to buy expensive insurance to cover all and every eventuality. In fact, unpacking this equation could actually save them money.

Risk mitigation

Brokers and insurers who understand a charity’s work know the risks it’s most vulnerable to. They will suggest relevant products accordingly.

In order to price the policy, they will also want to know what steps an organisation has taken to mitigate these risks. If a fifth of charities aren’t reviewing their arrangements for over three years, any risk management steps taken in the interim won’t be reflected in their premiums.

Indeed, if a charity puts risk management measures in place and their premiums stay the same, they need to ask their broker why.

When it comes to managing risk, ‘business as usual’ for charities and for-profits alike isn’t going to cut it in unpredictable times. Charities need to get a better handle on managing their risks – including becoming a lot more demanding when seeking the insurance to protect them.

Sush Amar is strategic communications writer at Lloyd's of London