Why Underwrite?

The title of a recent article I read was, “The Race to Zero in Small Commercial.” Zero referred to zero underwriting questions. No application required. I think that even beats the already existing three question applications.

On the same day, I read a short article from an insurtech company executive whining about how too many questions keep people from buying his insurance product.

Insurance is super simple to sell if there is no underwriting. Sales will absolutely increase because all of the people who could not previously afford insurance because they are bad risks will buy insurance now. It is the ultimate pool of large numbers.

Of course, insurance companies discovered a long time ago that if they did not underwrite, which means discriminating against poor risks, they would be inundated with bad risks, i.e., adverse selection. This would cause them financial difficulties and make premiums too expensive for good risks. Insurance operates under the 80/20 rule. It only takes a few relatively extra bad risks to destroy a company’s profitability and surplus. Insurance is designed to offer protection for otherwise good risks that have bad luck. At its most simple, insurance is simply a tool for offsetting bad luck.

Insurance is not designed for maintenance. Bad risks are a form of maintenance insurance because they have claims more often and/or more predictably. Any kind of situation where a predictability of breakdown exists account by account is more of a maintenance situation rather than an insurance situation.

Circling back to not asking underwriting questions, the unknown is whether property/casualty insurance turns into a maintenance policy rather than an insurance policy. Do carriers take all risks and simply adjust the pricing? Pricing is an underwriting tool because if the maintenance is projected to be too expensive, then the premium will be so high that customers will not buy the policy. From many angles, this is probably a better underwriting tool because the customer decides to opt out rather than the insurance company having to tell them they are a lousy risk. From a public perspective, using pricing as a blunt tool might not be such a good idea.

Possibly though, the new technology is so good that underwriting happens accurately without asking the consumer/business any questions. Humans’ answers to questions are simply noise in this space. In other words, a human’s answers to questions are irrelevant. I can see this because lots of applications have bad data based on humans’ answers. (Lots of databases have loads of bad data too, so this may be a case of half a dozen of one and six of another – time will tell.) If the algorithms are of high enough quality, underwriting and pricing will happen side by side, so interconnected that no one will be able to draw a line between these two variables.

Blending

This blending of variables is already causing anger and angst because carriers cannot explain their underwriting decisions to agents. They cannot explain to insurance commissioners the variables being used and how those variables alter the other variables because an infinite number of combinations are created. Some legitimacy exists to insurance company personnel who, when asked to explain their rate filing variables, advise that they cannot because a black box has been created.

The industry is without doubt going to eliminate humans in the underwriting process at the agency level for certain and within carriers for everything less than middle market commercial, and probably halfway through middle market commercial, too.

For underwriters, you need to figure out how to be an underwriter in a more complex world if you want to remain in underwriting. That is your only option. Otherwise, learn to program underwriting systems or sell insurance, or retire.

For agents, upfront underwriting on those accounts is dead. The carriers simply have not signed the death certificate yet for many different reasons. They need to improve their own internal systems. Some do not have quality underwriting/pricing systems, which means they are behind. Some are simply nice people and do not want to upset things until the last minute. In some cases, the carriers’ leaders do not know how to lead without underwriters, so until the next set of leaders arrives, the carrier is not going to change. They will be behind though if the leadership change takes too long.

For agents, this means carriers need more organic growth. Historically, agents existed to service accounts, grow organically and upfront underwrite. Agents were paid renewal commissions for the first, new business commissions for the second and profit sharing for the third. The more companies go to automated underwriting systems, the less important traditional profit sharing will be because they do not need agents to upfront underwrite. Carriers need agents to sell and service, and they need agents to do both more efficiently.

This need is reflected in how profit sharing is focused on policy growth. A key question I hear people ask is whether automated systems are more accurate than people in underwriting. I do not know. I know a lot of really good upfront underwriting agents and underwriters. I have known my share of agents who could not underwrite someone with four DUIs, too. Accuracy, however, is not the only factor and maybe not the primary factor. The other factor, and the primary factor in some lines, is expense. The systems are cheaper than humans, and even if they prove to be less accurate than humans, the systems will win every time if the expense savings exceed the additional errors by a large enough percentage.

Bottom Line

The bottom line on these developments for agencies is organic growth is king. The serial acquirers and the publicly traded brokers are not generating material organic growth for carriers. Carriers feel they can manage their loss ratios without agents now, but they cannot grow adequately without agents. If their agents cannot generate adequate organic growth, the carriers must sell themselves or disintermediate agents. It is simple and a matter of survival. Agents who want to be part of the solution and are willing to do the hard work to be the solution are probably in the best position with the most opportunities in 20 years. Not having to complete applications should be music to your ears, too. The agents complaining about the loss of filling out applications are probably the same agents who bring zero value to clients, cannot otherwise grow and do not know what to do with their time if they are not completing applications.

This is a paradigm change, and paradigm changes force cultural and leadership changes. Are you aligned with carriers that can make the transition? Is your agency prepared to make the transition?