Seeing something through can have quite a bit of meaning, especially when underwriting margins are thin and policyholders are struggling to pay bills. Transparency is a buzz word of sorts and continues to be a challenge for the insurance industry. Given the struggles of premium volume and profitability, it may just be the difference between profit and loss.
Three key aspects of a given risk are ideally used to determine underwriting acceptability and pricing. They are: exposure, loss history and hazard/account characteristics. Because discipline is more commonly exercised regarding the first two aspects, actuaries typically lend exposure and loss history some credibility. Files are rarely reviewed to check the credibility of documentation regarding these aspects.
When are loss runs considered real, and when should they be verified? Hopefully this is a rare issue to bring up. Exposure, though, is muddled data at best for those accounts not enjoying a physical audit. Phone audits (with under a 25 percent industry-wide completion rate) typically result in policyholders referring to their premium basis and picking a number that’s convenient. Post card audits are not much different. The complications of non-audited policies are self evident.
I wonder how many small trade contractors are just being humble.
Cost is a factor. Physical audits average $400 per file, when including expenses. The audit is a representation of what records were volunteered by the client. Rarely do the actual records (tax returns, payroll information, etc.) accompany the report. Ultimately, the cost is prohibitive for small accounts, but where does that leave pricing? If small account rates are based on the same loss cost modifier (LCM) as larger, exposure verified accounts, then under-pricing is likely. This could be severe and rampant, particularly when most crucial, i.e., when a soft market meets hard economic times.
As carriers and program managers are reluctant to reduce human resource expenses (talent), premium volumes must be maintained. By either consciously cutting rate, or unconsciously via unverified exposure, the underwriting thought process may boil down to two questions:
- Do I want this account?
- How much credit must I give to earn the business?
As every hard market turns soft, insurance companies incessantly trumpet that they “will hold the line.” They will protect the bottom-line by accurately underwriting each risk. The reality is soft market underwriting becomes an endeavor to reduce audit and loss control expenses and boost premium volumes through account acquisition. Underwriting guidelines are compromised and the painful oscillation of an industry cycle is perpetuated.
Let’s analyze the underwriting questions.
Do I want this account? Too many times we see loss ratio drive the decision (loss free = good to go). With loss free accounts in mind, are the premiums performing on purpose or by accident? As account size decreases, the luck involved increases. Such accounts become more volatile and risky to underwrite. So, is the solution to command higher minimum premiums? While a few more premium dollars never hurt, it may be best to gain more insight into the risk. Rolling up the sleeves and asking questions about business practices and specific hazards is always a good practice. Getting documentation to verify the answers, makes this true form of underwriting credible and worthwhile.
Where do I need to be to write it? How much credit must I give to earn the business? The question clearly sees underwriting as an art, rather than a science. Underwriting acceptability should not be a blank check. Assuming credible (and thorough) documentation of exposure and history, how can the underwriter gauge where “the line” is by which to hold for each account? The common answer: see the supplemental application.
Supplemental applications are only as credible as the person completing them. Policyholders sign “agent prepared” supplemental applications (post binding) all the time. Some wholesale brokers even prep the supplemental for their agents (yeah, it happens). Even if the policyholder is the author, supporting documentation to critical answers is rarely provided.
Questions are a key starting point to good underwriting – agreed. But discerning the credibility of the answers is when most balls are dropped, exposing profitability and creating many unknown variables, each of which can invite access to policy limits and red ink.
At least with “short tail” business the resulting impact on profitability from these problems can be determined, and adjustments made, before losses become critical. What about all the “long tail” business? Will the soft market harden in time to offset the above mentioned underwriting challenges? Could things ever “harden” enough? No wonder carriers “get while the gettin’s good” during hard market times.
Question is … Will you get enough next time to cover the unknowns on your books right now?