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The 2 roads to new business
1. Direct underwriting - Insurance carriers that source their own business
2. Indirect/program business - Insurance carriers that empower others to write business on their behalf.
- The insurance carrier makes an agreement with a managing general agent (MGA) to source policies for the carrier.
- The MGA can underwrite and price business on its own and issue on the carrier's paper.
- The carrier must rely on the MGA's systems and metrics.
When it comes to maximizing underwriting revenue, many property and casualty (P&C) insurance companies are missing some key ingredients. Many firms — even the large international P&C companies — do not generate the data or metrics they need to monitor and manage their underwriting operations effectively. In other cases, insurers are choosing to focus only on written premium volume and calendar year combined ratios, which are only part of the story.
As we look ahead, it will be critical for companies to generate increased margins from underwriting since low interest rates mean investment operations will contribute less toward total return on equity (ROE).
It wasn’t that long ago that a P&C insurance company could generate 75% of its ROE goal from its investment portfolio. For example, if a company’s ROE goal is 12%, 9% would be produced from investments and 3% from the underwriting operations. To produce a 3% underwriting return, a company could write to a 98-100 combined ratio, depending on a company’s operating and investment leverage. In today’s low-interest rate environment, a company will need its underwriting operation to produce approximately 50% of its ROE goal — which translates into a 90-92 combined ratio.
In short, getting a handle on underwriting metrics can significantly
boost profitability. How an insurer sources business must be a part of
any improvement initiatives as well. To improve profitability on
underwriting margins, insurers must calculate and analyze five key
metrics on at least a monthly basis.
Metric No. 1: New business success rate
Success means writing new business. Understanding where new business comes from means developing and analyzing metrics to identify where the P&C insurer has been successful (or unsuccessful) in writing new business in the past. Some key guideposts are measuring submission activity through to new business premium and average new business account size written. In addition, it is critical that these metrics be generated at an underwriter, agent, line of business and product level to fully understand where the insurer’s operating performance is exceeding or falling short of expectations.
Metric No. 2: Renewal retention statistics
Growing a company’s premium volume begins with retaining existing clients. Insurance companies should measure their ability to retain existing clients on both an account and premium basis. For example, by measuring both accounts and premiums, a company will be able to determine if they are more or less successful in retaining large versus small clients. Similarly, other measures can be used to identify the most profitable customers. The metrics should reflect more than just volume — the quality of the business can be even more important.
Like new business, the renewal retention statistics should be produced at an underwriter, agent, line of business and product level to fully understand where the company’s retention results are exceeding or falling short of expectations. The denominator for the retention ratio calculation should be the expiring number of accounts and corresponding expiring premium immediately before the expiration month. The numerator for the retention ratio calculation should be the number of accounts renewed and the corresponding renewal premium, excluding price and exposure changes at renewal.
Any further analysis should take your distribution channels into account. Oftentimes the metrics related to direct and/or indirect business can increase your ability to analyze the retention ratios even further.
Metric No. 3: Pricing
With the wide range of rating algorithms and classes and lines of business, building a data-driven rate-monitoring database and reporting mechanism is the most challenging metric for an insurance company to generate. Yet, there is no metric more important in determining if an insurance company is on target to achieve its underwriting margins than how its book of business is priced compared to manual rate levels and rates charged on the expiring book of business.
When developing pricing metrics, comparisons need to track price levels for new business separate from renewals and changes in its manual rate levels separate from changes in judgmental (discretionary) price levels. Pricing levels should also be measured by underwriter, agent, line of business and product, and include additional coverages, not just base rate changes. Also, price levels should be adjusted for changes in limits of liability and deductibles.
There must be an appropriate level of granularity from both indirect and direct business for pricing — the ultimate goal for any insurer is a uniform platform to run those pricing metrics. This is not always possible because of aging legacy systems, which can be financially prohibitive to replace. For many insurers, it seems more palatable to maintain the existing underwriting, policy issuance and claims systems. This leaves them in a quandary — not getting the data they need, but believing their situation is less painful than making a major investment of time and money in new, up-to-date systems.
Many insurers haven’t considered viable “bridge solutions,” which are designed to squeeze more out of existing systems without major investments. When purchasing new technology is not feasible, management should fully explore this option.
Metric No. 4: Execution of claims best practices
If you asked a P&C insurance CEO or chief claims officer to describe their claims best practices, they might list the following:
A gap analysis can identify target improvement areas
- Assignment and early contact
- Coverage confirmation and analysis
- Investigation Evaluation Reserving
- Litigation management
- Negotiation and disposition
- Subrogation, special investigations unit and salvage/recovery
- Reinsurance and notification
- File management and documentation
Grant Thornton LLP often works with insurers to analyze operational platforms and/or systems to get them to a target underwriting model. We recommend performing a gap analysis that benchmarks the company’s underwriting operations with best-in-class companies and processes — the gaps that emerge can be isolated, and relevant strategies can be built. In most cases examining and acting upon the five metrics we discuss here will assist in this process.
However, if you ask these same executives to produce a financial report that lists metrics that monitor the level of execution of these claims best practices, few would have metrics to share with you.
Each of these claims best practices can be measured, and, ultimately, these measurements would indicate if a company is overpaying claims. For example, assignment and early contact can be measured in three areas:
1. Time between the date of loss and the date the claim was reported to the company
2. Time between report date of the claim and date assigned to the claim examiner
3. Time between date of assignment and date that examiner contacted all applicable parties for the claim
Some of these claims best practices will be difficult to quantify by way of an automated report. However, quality assurance reviews could be used to supplement quantitative metrics in this area.
No matter what strategy the insurer uses, speeding up the process is a clear best practice. Historical data supports that the longer the time frames, the more likely the examiner will need to pay a higher amount to close the claim file.
Metric No. 5: Accident year limited loss and allocated loss adjustment expense ratio
Limiting losses to a frequency level in an accident year loss and allocated loss adjustment expense (LAE) ratio is the best way to evaluate the performance of an underwriting operation. An accident year approach is better than a calendar year approach because prior year reserve changes are properly reflected in their appropriate accident year.
Additionally, by limiting losses to a frequency layer, it allows insurers to understand how the occurrence or absence of large losses affects current profitability. Finally, by excluding unallocated LAE (the costs of a company’s in-house claims staff), this metric helps insurers zero in on all external costs of the claim adjustment process. Like the metrics described earlier, companies should generate accident year loss and allocated LAE ratios at the underwriter, agent, line of business and product level, and the reports should include the three latest accident years in order to review trends over time.
Continued low-interest rates mean that P&C leadership teams are facing mounting pressure to generate heftier margins from their underwriting operations. Now more than ever, these firms will need to generate the right data and metrics to help them determine what’s profitable and what’s not.