Should Financial Institutions Benchmark Their Insurance Purchases?

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insurance benchmarking: is there wisdom in crowds?

There are two opposing theories about listening to the crowd. Do and don’t.

Should a financial institution buy the same insurance and the same limits as a competitor simply because they share certain attributes?

Benefits of Benchmarking

There is no arguing that there can be safety in numbers, and for many years people played it safe following such age-old adages as “no one ever got fired for buying IBM.” Still we find it weak to simply follow the herd. Yet sometimes, in certain matters, the herd is right.

In 1906 an English scientist named Francis Galton visited a country fair where they were playing the rural version of guess the weight – in this case the weight of an ox. When the average of the nearly 800 guesses came within one pound, the scientist was astounded. The assembled wisdom of the crowd had bested any of the experienced cattle breeders. (Galton later went on to develop the concept of standard deviation.)

Benchmarking has become a standard tool of the modern age. We have grown up with bell curves, a form of benchmarking, and while we may have hated them in school, we recognize their value. Under certain conditions ignoring the outliers and focusing our energies on the common, on the likely, can often increase productivity. Benchmarking, it can be argued, is a way of learning from other people’s experience and avoiding the mistakes they may have made. We respect and even revere that application of accumulated knowledge. It was Isaac Newton, after all, who said, “If I have seen further it is by standing on the shoulders of giants.”

Benchmarking is way of measuring what other people have learned.

The Pitfalls of Benchmarking

However, the misapplication of benchmarks, or simply following the crowd, can also lead to spectacular failures.

When it comes to the majority being misled we need look no further than the real estate bubble leading to the 2008 financial crisis. Sometimes the majority is simply wrong. We have seen it time and again. Every financial bubble through the ages (tulips, South Sea stock, the roaring twenties) is an example of “mob-mentality.” Going along with the crowd has led to atrocities and embarrassments (think bell-bottoms and Kardashians).

There is no need to belabor the point; we all recognize that simply following the herd sometimes leads to poor economic decisions.

Why Insurance Benchmarks Must Be Used With Caution

If benchmarking what coverage and limits your competition is buying is less than a perfect way to evaluate your own insurance purchase, why do it? Benchmarking does provide a convenient starting place for institutions considering new coverages. However the two principal reasons for using benchmarking are really convenience and cover. The two reasons for ignoring benchmarking are that no two financial institutions face exactly the same risks or have the same risk appetite and, perhaps more compelling, insurance is not about finding an average – it’s about the outliers: protection from the storm, the unexpected lawsuit, the unprecedented cyber attack.

It’s not wrong to benchmark. Just put the results in perspective and don’t let the crowd determine what’s right for your needs.

 

About Richard Magrann-Wells

Richard is a Executive Vice President with Willis Towers Watson’s Financial Institutions Group based in Los Angel…
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