We need to specify what we mean first. In certain industries with great standardisation in a mass market, efficiency is, in effect, effectiveness. The efficacy of McDonalds’ business model is its very efficiency, and this is what makes them so effective. It isn’t effortless: they work effing hard at keeping costs low in delivering N burgers per M employees per hour.
But this isn’t the case for insurance. While it varies by line of business, a typical model breaking down 100% of the total premium (i.e. decomposing the combined ratio) would look something like this:
Our focus area for seeking efficiency improvements is just 15% of total revenues. If we work really hard and get our expenses down by 5%, then we have improved combined ratio by 0.75%.
We could do better looking at those acquisition costs (usually broker commissions). It’s a truism in the industry that brokers’ margins are both more certain than insurers’, and larger. This is a negotiation challenge, and worth pursuing: but to a degree this depends on the power dynamics of insurers vs brokers, and often the “rain makers” that the brokers are hold the upper hand.
But look at the 60% loss ratio. It’s too often reckoned this is a given: the market (and market cycle) permits a loss ratio of a certain level in a given year. Well, this is plain wrong. Even if you’re really big, there are always opportunities if you make the effort to find improvements in loss ratio. This is portfolio management, and it is what we do at Calibrant and Sybil. For smaller players, or those with a niche, the benefits of portfolio management are even higher. The improvements from strong portfolio management discipline are enduring, and typically range between 1 – 5 points of loss ratio.
Suppose it’s possible to take just 1.5 percentage-points off the loss ratio. This delivers twice as much benefit as a hard-fought 5% reduction in cost base. And in my experience it is far, far easier, far less traumatic, and better for the culture of the firm.
What does this have to do with effectiveness? Well, underwriting is about decision-making, and effective underwriting is effective decision-making. I can’t imagine a better or clearer measure of effectiveness in underwriting than in the loss ratio. And so effective underwriting represents far more fertile land to plough than the barren wastes of efficient operations.
Why is there so much noise on expenses in insurance, then? There may be an element of Finance and Operations holding more sway than Underwriting. But I think it’s probably just a question of awareness. Expenses are there, in your face: that person sitting opposite you costs £X per year. Those business trips cost £Y. But a loss ratio is more abstract, and improving it yet more so.
An insurer needs to conceive of the benefits of portfolio management, and believe they will deliver enduring loss ratio improvements. If this is something they can get behind, then portfolio management is an inexpensive and highly attractive way to deliver improved performance. Underwriters need to be bold and stand their ground, arguing for example that projects should be funded based on loss ratio improvements and not just dry financial cost-benefit analysis.
Underwriting is the most important function in most insurers, and its influence should be paramount in driving corporate focus. Specifically, remember that readily-accessible improvements in underwriting effectiveness are worth at least double what traumatic and hard-fought improvements in efficiency can deliver.
Effectiveness trumps efficiency. Focus on being good, not lean.
There has been a lot of speculation recently around the use of AI in insurance and how this signals the death knell for Underwriters. Having mopped up the coffee that I spat out and checked my life insurance provisions, this got me to thinking. Surely not all underwriters? But if not, then who?
We have all heard of the boiling frog syndrome which says: if a frog is put in boiling water, it will jump out to protect itself. However, if you place a frog in cold water and slowly turn up the heat, it won’t notice the subtle increase in temperature and be boiled alive.
Game theory aims to shed light on outcomes where multiple actors operate. Dry academe often assumes “ceteris paribus” even in social sciences, but in the real world when we are trying to anticipate the outcomes of decisions one actor makes it is essential to consider the possible and likely responses of other actors…
In various parts of our lives, we are examined and tested to grade our ability and knowledge, be that driving tests, ‘A’ levels, or piano exams.
And so it is with the insurance industry. Boards and regulators are increasingly pushing for demonstrable oversight. This is especially true in the field of Delegated Authority (DA)…
Managing General Agents (MGAs) provide insurers a broad opportunity for profitable growth. Operating in niche sectors with lean efficient models and providing customers with products that they often find hard to come by in the mainstream. All of this is wrapped up with the relevant expertise and providing insurers with access to markets that…
As 2022 was drawing to a close, insurers across the UK were starting to look at their results, keeping their fingers, toes and everything else that they could, crossed in the hope that December would fizzle out in a whimper.
But alas it was not to be as temperatures plummeted and the industry suffered…
What use statisticians and actuaries when the world is being transformed by modern data-analysis techniques? What hope for clunking humans in the era of Big Data (Facebook sells data which influences US presidential elections), of Artificial Intelligence (China can identify disliked racial groups through automatic facial recognition technology)…
Catastrophes – natural events where one “system” (wind, earthquake etc) causes multiple insurance claims in one go – are difficult. Much else in insurance pricing is subject to conceptually simple averaging-over-time, but cats are different. You can’t take a 5 or 10 year history of natural-peril losses and assume you have an accurate view of exposure to catastrophes…
In part 1 of this triptych on insurance pricing we looked at Technical Price (TP): what must be covered over the long run to make reasonable profits. I finished that note by considering TP in the context of the market. Here, I take this theme further and explore more how to think strategically about pricing.
This note covers the fundamentals: the three building blocks of a technical price and a note on the role technical price plays. It is followed with a deeper look at pricing strategies. Finally we consider a knotty topic, cat(astrophe) pricing, in particular the use of cat models to inform the price.
On 26th September 1983, at the height of the Cold War, Soviet missile monitoring picked up apparent signs of five nuclear missiles launched from the US. Retaliation was the default planned reaction.
Charles Dickens opened A Tale of Two Cities with these lines, contrasting calm enlightenment London with turbulent revolutionary Paris: “It was the best of times, it was the worst of times…
Calibrant was established to bridge a gap. The gap is that between MGAs and their carriers. And it finds many forms.