In the last several months, economic challenges have arisen globally on a scale that few could have predicted, and many thought were impossible. The escalation of the subprime crisis into a full-blown financial meltdown has brought once-invincible institutions to their knees, led to the effective nationalization of banks around the world, and destroyed organizational reputations on a scale unseen for almost a century, with extended effects impacting leading players in the insurance sector.

Governments have scrambled to respond quickly to the unfolding events, and political dogma has been torn up and thrown aside when faced with the immediate need to stem the tide. The effects are being felt in every industry, in every country, and in every household as credit markets dry up, firms struggle to renew their financing arrangements, jobs are cut, and people lose their homes.

Faced with these unprecedented events, insurance clients have been asking for ways to respond. Global businesses want more information, ways to deal with the immediate effects of the crisis, and help in preparing for whatever might be coming next. Counter-party risk has become more important than ever as an issue on boardroom agendas, with firms evaluating trading partners of all kinds more closely than ever before.

Insurance companies are particularly in the spotlight, not least because of the double hit of higher-than-expected write-downs on insurance client investment portfolios, and the high cost of the 2008 hurricane season. Premium rates are already hardening in some lines, particularly in specialist markets such as energy and aviation, and developments in the reinsurance markets are indicating more general increases. Even if their own rates have not yet risen, insurance clients are considering what steps they should be taking if we at Aon see insurance markets harden across the board.

Credit Default Swaps

Inevitably, there are signs of a flight to quality, with the creditworthiness of insurers becoming even more important than normal and a desire for additional sources of information beyond traditional credit ratings. The pricing of Credit Default Swaps is very much in the spotlight, with price trends and pricing spreads scrutinized in the search for a reliable forward indicator of future performance. The industry is already responding with new ways to manage counter-party risks and to build more protection into diversified risk programs, evidence that even in a crisis of this scale, effective solutions can be found.

Insurance brokers are not immune to these concerns, and we at Aon are also seeing some firms reviewing the creditworthiness and future reliability of their broking partners. In times like these, a strong balance sheet provides perhaps the best protection of all. Our own financial strength has allowed Aon to complete the combination of Benfield and Aon Re Global, despite the financial markets’ turmoil, uniting some of the best minds in the industry in a cash deal that will deliver added value for Aon clients well into the future.

In such interesting times, the importance of good, effective risk management has never been higher. Many of the firms at the epicenter of the financial crisis suffered not because they lacked good risk management protocols and processes, but rather because they overlooked the results of the analysis, perhaps blinded by the belief that higher-than-average returns could be achieved without higher-than-average risk.

Now is the time for firms to redouble their focus on good risk management and to look at their own risk portfolio with the same dispassionate gaze that hindsight is bringing to bear on the fallen financial giants. It’s important not to be fixated on the risks that brought them down, far-reaching though they are, but to look for the equivalent risks in your own portfolio: the risks that everyone acknowledges are huge, but which formerly prevailing wisdom says couldn’t happen. It may also be time to reconsider where risk management fits in your organization—whether it should be part of the line management structure or an independent voice with a direct line to the board.