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Risk of Short Term Thinking in Insurance
October 01, 2013
If ever there were an industry where quarterly reporting of results brought unintended consequences, it would be insurance.
For many industries, quarters are perfectly suitable periods in which to measure sales, growth, profit and other financial metrics. But most lines of insurance have policy periods no shorter than 12 months. Looking at insurance results quarter by quarter seems premature, and possibly harmful.
Short-term financial reporting tends to promote short-term thinking, and that has significant downside risks for all involved in coverage placement.
From a pricing perspective, it takes at least the policy period to determine whether the underwriter priced the risk appropriately. If priced correctly, the carrier can make an underwriting profit. If underpriced, the carrier may not meet its cost of capital – and that is not a sustainable business. Either way, the ultimate return on a risk bound in January cannot be known three months later. For that reason, investors in publicly traded stock insurance companies are better served by taking a longer-term view themselves, but that’s a subject for another discussion.
Among the negatives of short-term thinking in insurance:
One of the historical truisms of insurance is that it’s a business built on relationships. A tripartite relationship works well. Buyer, intermediary and underwriter – each needs to take a longer-term view to derive the most value from this relationship.
Here are some examples of short-term thinking, by each party:
A buyer purchases mainly on price and/or rating, overlooking the carrier’s track record in financial strength, claims-paying history and risk appetite. Some price-sensitive buyers go to market every renewal, but they would be better off investing time in helping carriers understand their risks to provide fair pricing.
A broker gets a deal done, even if it isn’t in the client’s long-term interest – or the underwriter’s. A venerable Lloyd’s underwriter once said, “Brokers are expert at testing the egos of underwriters – ‘you can write that risk!’” and often enough, an undisciplined underwriter does, to subsequent regret. Brokers earn commissions or fees for the placement, but typically not the end result. The strongest, most enduring relationships focus on long-term positive results for all involved.
An underwriter decides to make budget, shortcutting standards to satisfy a near-term need, such as market share. This often causes pain down the road – poor results for the carrier and market contraction for buyers. It’s especially unhelpful to buyers when carriers shrink their risk appetites after losses occur.
Here are some ways to avoid short-term thinking:
Buyers need to see the big picture and consider carriers as financial partners – their balance sheets are on the line. Look at price but also consider terms, conditions, capacity, risk appetite and claims-payment history. Questions worth asking: What are the carrier’s financial strength and creditworthiness ratings? Was the carrier willing to quote competitively? How much consideration did the underwriter give to the risk submission? Did the carrier distinguish itself in handling previous claims?
Often, intermediaries are better able than the policyholder to know a carrier’s tendencies in certain risks or lines of business and responsiveness on claims. Brokers are in the marketplace every day, whereas buyers are not. Therefore, brokers can assess and advise on which carriers might make the best fit for the client’s need – even though the client has the final decision over where ultimately to place its risks. Be transparent with clients and carriers. Be willing to push each party to achieve an optimal result. The best deals benefit all involved.
Underwriters should view policyholders as partners whose participation determines the carrier’s own success or failure. Focus on meeting the buyer’s needs and the value delivered, not just on booking premium. If the buyer perceives value is lacking, remember that account can go elsewhere. Sometimes there are ways to address a policyholder’s problems that do not require assuming additional risk – the goodwill will pay dividends later.
Regis Coccia is an insurance journalist and content strategist. His columns on insurance and risk topics appear periodically on Fast Fast Forward.
The views expressed in this column are the opinions of the author and do not necessarily reflect the opinions of XL Group.