A Disciplined Approach to Underwriting

Now that 2011 is in the record books, various insurance company presidents soon will be disclosing and discussing their company’s year-end results. While the exact words may be different, don’t be surprised if they all sound something like:

The pricing issue is pretty easy to decipher, but what, exactly, is “underwriting discipline?”

Underwriting is obviously not an exact science; and unfortunately insurance companies don’t know the ultimate cost of a particular policy until long after it has expired. For our purposes, “underwriting discipline” is nothing more than properly evaluating a risk and making rational, reasonable decisions on acceptability, pricing and coverage. Over the past eight years we, the industry, have become a bit sloppy in applying these principles. As a result, some companies need to apply some corrective action to get their house in order. So, what are the signs that a particular insurance company has entered the “era of underwriting discipline?”

What Does the Insured Do?

Although this seems to be an obvious question (it’s even on the application), in the haste to get a quote and sell the account, this important piece of the puzzle is sometimes missing. Take a distributor for example. Would it matter to the underwriter if the insured was distributing silverware (i.e., knives and forks) or replacement parts for an airplane? Acceptability, pricing and terms vary greatly for such disparate accounts, and should because the loss exposure is so much greater for the airplane parts distributor than the silverware distributor.

Questions and More Questions

Directly related to figuring out what the insured does, expect the underwriter to ask you many more questions, for both new and renewal accounts, in an era of renewed “underwriting discipline.” Last year I witnessed an example exactly the opposite of “underwriting discipline.” An agent submitted an application on a contractor. The “disciplined” underwriter contacted the agent to request some basic information: payroll, receipts, and what, specifically, the insured did. The agent said, “Please close your file. I have already received a quote from two markets with the information I sent you.” Say what? How can two carriers quote a risk when they know so little about it? In the insurance world, it’s not what a carrier knows about an account that will hurt it, but what it doesn’t know.

The Match Game

Insurance Services Office (ISO) loss costs reflect an average rate for risks that exhibit average underwriting characteristics. In any class of business, there are accounts that deserve to pay less than the average rate and others that should pay more. This is Underwriting 101. Companies get into trouble when they charge below average rates for risks with above average loss potential. Long-term success in insurance requires that the rate (and ultimately the premium) charged matches the loss exposure presented. Disciplined underwriters must assure that risks with a higher probability of loss pay more.

A Form by Any Other Name

During competitive insurance markets carriers often enhance their policy forms to provide more protection. Examples include adding hired and non-owned auto, increased crime coverage limits, blanket additional insured and waiver of subrogation endorsements — all at little or no additional premium. It is no secret that losses for these added coverages will eventually mount; when this occurs insureds should expect the introduction of endorsements designed to limit or exclude certain coverages along with the possibility of higher premiums and additional costs. It is important that such changes be communicated to policyholders before something unexpected happens.

Great Expectations

There are producers who have entered the insurance business in the past eight years and have never experienced the hardening of the market. They have “grown up” in insurance with the idea that every account, new or renewal, qualifies for a premium reduction. Several years ago an underwriter relayed the following story to me. She received a submission from a retailer for a general liability (GL) quote on a rather large schedule of apartments. The narrative read something like this:

“See the attached ACORD forms and loss runs. The incumbent carrier is non-renewing due to a frequency of large losses. Please provide your most favorable pricing and terms as soon as possible. I need to be able to offer similar pricing and coverages in order to retain the account.”

Okay, let’s review. The current carrier is electing to terminate the risk due to a number of large losses. For us to write the account, the agent requires us to do so with the same pricing and coverage. Uh, I don’t think so, Scooter!

I don’t fault the agent for working hard for his client, which is what he is paid to do. But the reality is that writing a difficult, historically unprofitable risk requires some coverage and pricing adjustments to make it acceptable. Disciplined underwriters know that managing the expectations of agents — wholesale and retail — and insureds is challenging, but necessary.

Topics Carriers Agencies Profit Loss Underwriting