To Manage the Cycle Effectively, Focus on Underwriters’ Behavior

November 14, 2024 by and

Executive summary: When actual prices line up with technical prices, insurers expect underwriting profits to emerge. But what if underwriters find ways to adjust technical prices downwards? In the second part of a two-part series, Tony Buckle and John Carolin, co-founders of the insurance consultancy UWX, suggest that truer leading indicators of performance come from listening to the open and honest assessments of underwriters and keeping track of the actions of managers. Related part 1 article: Soft Commercial Market Ahead: Prepare for Underwriter ‘Herd Behavior’.

Prices are under pressure in many insurance markets.

After an extended period where pricing levels have risen and held at profitable levels, the balance of power appears to be shifting to buyers. In segments such as management liability and cyber, this shift has been dramatic, with loss-free accounts attracting reductions of 50% or more year on year.

“When the herd moves, it moves,” as the former British Prime Minister Boris Johnson once ruefully said. Momentum shifts are tough to manage. [inline-ad-1]

Momentum shifts, such as those seen in a softening market, are even tougher. They prompt fear and irrational actions as the following quote from our research illustrates.

“We knew terms and conditions were not good, but the competitors wrote it if we did not.”—Senior Underwriter, Global Insurer, EMEA.

To paraphrase Rudyard Kipling, how do you keep your head when all about you are losing theirs?

“The key is to plan for market softening now, when insurance markets remain relatively robust, portfolios profitable and emotions in check. With cool heads, define now the actions you want to take when markets soften.”

The key is to plan for market softening now, when insurance markets remain relatively robust, portfolios profitable and emotions in check. With cool heads, define now the actions you want to take when markets soften. It is far easier to draw red lines when profits are strong than when “under the pump” of an ambitious premium target in a plunging market.

The key to planning is knowing when to act—when to apply the brakes and also when to press the accelerator. This requires metrics that are focused on leading indicators of performance, i.e., measuring the activities today that will drive the results in the future. Lagging indicators of performance that focus on the outcomes of yesterday’s actions, such as accounting profit, come far too late for timely management intervention.

The shift to true leading indicators is not straightforward. Many carriers employ pricing outcomes as leading indicators, such as technical price adequacy, which tracks the actual price achieved in the market relative to the technical price the particular risk required. This sounds reasonable, until you assess the behavior around the calculation of technical price.

Tweaking the Tools

Behavior was the focus of the UWX research, and the study found that tools were regularly manipulated to achieve the desired outcome. Here are sample quotes from across the globe:

  • “When you’re under pressure to write you’re going to tweak the tools …. you will kind of game the tool.”—Underwriting Manager, Reinsurer, EMEA.
  • “They were using the tools, but they were gaming them to get the answer that they wanted.”—Underwriting Manager, Global Insurer, Asia.
  • “There was a bit of a game to make it work for us so that we could still have price flexibility by twisting the tools.”—Senior Underwriter, Reinsurer, Asia.
  • “The tools were just tweaked in order to get some positive results” —Underwriting Manager, Reinsurer, Americas.

How objective is technical price if underwriters can manipulate the pricing tools to get to the price they need? How predictive of performance is technical price adequacy? How comparable are technical prices from different years? What does that imply about the rate adequacy and ultimate loss ratio of the portfolio as a whole?

What you really want to be measuring is pricing integrity, i.e., the behavior around pricing tool usage. How the tools are being used, or abused, is not only much more predictive of ultimate profitability but can also be assessed and addressed before the harm is done.

The UWX research showed further that there was a distinct cycle to behavior. The International Association of Engineering Insurers (IMIA) graph below shows rates for different types of engineering and construction insurance between 2002 and 2022. The shape of the graph will be familiar to underwriters in many lines of business. Rates declined steadily post the horrific terror events of Sept. 11, 2001 and hit their nadir in 2017/2018. From there, rates have recovered.

Combining the rates above into one line (shown in red in the chart below), UWX analysis overlaid the technical price adequacy of one particular engineering and construction portfolio over the same period (shown in blue below). What can be seen is that as long as price adequacy remained above 100%, portfolio rate adequacy essentially moved in line with overall market rates. However, once price adequacy approached 100%, the lines deviated.

There could be multiple explanations for this. It could be that underwriters of this particular portfolio rejected any risks that priced below 100% technical rate adequacy. Perhaps underwriters replaced rate inadequate risks with rate adequate ones. Or perhaps underwriters found ways to adjust the technical price downwards? Whatever the cause, our point is that there is a behavior change that can be measured and investigated.

Current control systems often unwittingly exacerbate the problem. For example, insurer guidelines often impose special rules around risks that do not achieve 100% rate adequacy. Combine that constraint with pressure to achieve premium targets in a plunging market, and you create the perfect storm. Compromises are made.

“Being a professional underwriter during the soft market at least in my experience was really compromising on a lot. On too much. That was, at least for me, the most difficult part. Knowing you’re doing something which is in principle wrong but just executing because that’s what you are requested to do.”—Underwriting Manager, Reinsurer, EMEA.

Behavior Is Key

One objection often leveled at behavioral measures—notably around perceptions and attitudes—is that staff are unwilling to “tell is as it is.” The UWX research does not support this. While compromises were made in the soft market, where management encouraged open and honest communication, open and honest communication is what they got. The problem was much more that underwriters’ views were either not sought, were ignored or were overridden, as the following quotes demonstrate:

  • “Personally speaking we didn’t get [listened to] at all here. We just got beaten up if you didn’t hit target”—Underwriting manager, global insurer, EMEA.
  • “[We said] ‘listen, if we grow now, the bottom line is going to be very negative’. We have foreseen a negative bottom line [but] not as bad as it has been afterwards.”—Underwriting Manager, Reinsurer, EMEA.
  • “For us as a line of business it was very clear that growing at that point in time was losing money.”—Underwriting Officer, Reinsurer, EMEA.

Unfortunately, current feedback mechanisms like annual employee engagement surveys are next to useless in this regard. They do not provide the timely or relevant feedback on market dynamics that managers need to steer their businesses effectively. The UWX study found that underwriters were highly engaged during the period 2013–2017. At the same time, they were decidedly clear-eyed about the prevailing market reality and the pressures upon them (for example, to hit premium targets). Measuring those sentiments, rather than engagement, would have been much more predictive of performance.

All these factors drive pricing tool adjustments that impact the technical price.
[/sidebar]

Best-in-class insurers have long recognized such problems. They are recognizing how market forces can affect metrics like cost ratio, net promoter score and market share and how these can encourage unprofitable underwriting if not contextualized. Most important, they focus on measuring behaviors, not just among their own underwriters but across the market.

It would be wrong however to focus exclusively on underwriter behavior. It is vital to also measure management actions in respect of underwriting. Increasing premium targets in a softening market for example. Or more specifically, tracking the number of deals being escalated to executive level for decision-making. Such metrics provide useful insight into management discipline.

By measuring behaviors, forward-thinking carriers can measure how the market and their own underwriters are really trading, in near enough real-time. They can proactively recognize where the herd is moving and anticipate what will happen next. While they cannot necessarily choose the direction of travel, they can choose whether they go along for the ride.

Here are the key questions an insurer should consider asking about its cycle strategy:

  • How do we measure performance? For example, are we measuring leading or lagging indicators of performance?
  • What assumptions are we making about behavior? For example, are we assuming underwriters will miss premium targets if they cannot source appropriate risks?
  • Which of our metrics are a-cyclical, counter-cyclical or pro-cyclical? For example, is cost ratio just encouraging us to retain/write poor business in a softening market?
  • How can we bring stakeholders across our organization on the journey? For example, what can we do now so that stakeholders know how we will act in a softening market?
  • How do we communicate our strategy effectively externally? For example, how can we help brokers to better manage their clients’ expectations of our support and service?

This article is based on research conducted by UWX AG, the commercial underwriting-focused consulting firm based in Switzerland, which was co-founded by Tony Buckle and John Carolin, CFA. Specifically, the article draws upon research Buckle conducted with the support of the International Association of Engineering Insurers (IMIA) for his doctoral dissertation at SBS Swiss Business School, and by Carolin, along with the support of Amazon Web Services. As part of the research, they interviewed underwriting officers, underwriting managers and senior underwriters in engineering and construction.

This article first was published by Insurance Journal’s sister publication, Carrier Management.

Related articles:

Popular Today