Commercial Insurers Face Tough Times

Beyond the secular forces we described in our "Future of Insurance" series, more immediate and cyclical issues will be shaping the insurance executive agenda in 2016. Commercial insurers (including reinsurers) face tough times ahead, with underwriting margins that are being pressured by softening prices and a potentially volatile interest rate environment. Recently, reserve releases, generally declining frequency and severity trends, as well as lower-than-average catastrophe losses have allowed commercial insurers to report generally strong underwriting results. However, redundant reserves are being (or have been) depleted, and the odds of a continued benign catastrophe environment are low. For example, one insurance executive recently observed, “The odds of this long of a lucky streak occurring is less than 1%.” The commercial insurance market has, in recent years, had generally strong underwriting results, but this could change—potentially, very soon. With varying degrees of focus, commercial P&C insurers have been mitigating the risk environment by taking a variety of strategic actions. In 2016 and beyond, they will need to accelerate their strategic efforts in four key areas: 1) core systems and data quality, 2) new products, pricing discipline and terms and conditions, 3) corporate development and 4) talent management. Core systems and data quality 93% of insurance CEOs—a higher percentage than anywhere else in financial services—see data mining and analysis as more strategically important for their business than any other digital technology. Nevertheless, many commercial insurers operate with networks of legacy systems that complicate the timely extraction and analysis of data. This is no longer deemed acceptable, and leading insurers continue to transform their system environments as a result. Significantly, these transformations do not focus solely on specific systems for policy administration, claims, finance, etc. To ensure timely quality data across the entire commercial P&C value chain, commercial insurers also focus on how the various systems are integrated with one another. To put this into context, when a dollar of premium is collected, it not only “floats” across time until it is paid out in claims, it also “floats” across a variety of functions and their related systems: Billing systems process premium dollars; ceded reinsurance systems process treaty and facultative transactions; policy administration systems (PAS) process endorsement changes; claims systems process indemnity and expense payments. Actuarial systems in disconnected data environments prevent the timely and efficient extraction and analysis of internal data and also complicate the focused and efficient use of external data, especially unstructured data. “Big data” is becoming increasingly popular considering the insights that insurers and reinsurers can derive from it. However, such insights only become actionable to the extent that companies can assess the external environment in the context of the internal environment—in other words, to the extent that big data can enhance (or otherwise inform) the internal data’s findings. If all functional and systemic codes are not rationalized on an enterprise-wide basis, it is very difficult to efficiently accumulate and analyze data. New products, pricing discipline and terms and conditions Commercial insurers and reinsurers are not generally known as product innovators, but they can be. For example, as the profile of cyber-related risks increases, the need for cyber-related commercial insurance grows, thereby offering numerous opportunities for product innovation. Because cyber is a relatively new exposure, frequency and severity data are nascent, therefore both pricing and risk accumulation models are in various stages of development. As a result, prescient insurers are carefully tracking and comparing their cyber pricing practices and coverage grants with those of key competitors. To be effective, such practices should be consistent with existing price, terms and conditions and monitoring processes. For example, tracking actual-to-expected premiums and rates is a common practice, which leading insurers perform regularly (i.e., at least quarterly, with monthly tracking common). Insights from this kind of analysis apply to both new and existing products. The underwriting cycle is inherently a pricing phenomenon, and insurers and reinsurers that have greater and more timely product and pricing insights have a competitive advantage relative to those that do not. To explain, in addition to lower rates, the “soft” parts of the underwriting cycle tend to be characterized by the loosening of policy terms and conditions, which can erode profitability as quickly as inadequate prices. Therefore, the most competitive insurers and reinsurers carefully and continuously track the adequacy of policy terms and conditions. Recurring actuarial analyses and standardized reporting can monitor changes in pricing as well as in terms and conditions. However, identifying emerging underwriting risks is inherently qualitative. Therefore, this analysis can be time-consuming, especially for insurers with suboptimal PAS environments. However, almost all companies find the analysis well worth the effort. Corporate Development The combination of historically low interest rates, favorable frequency and severity trends and the relative lack of severe catastrophes has resulted in record policyholder surplus across P&C commercial insurance. Executives have a number of options on how to deploy surplus, one of which is corporate development. Commonly, “corporate development” means mergers and acquisitions, but it can also encompass book purchases/rolls, renewal rights and runoff purchases. Determining the best option depends on many factors, including purchase price, competitive implications and an assessment of how the acquired assets and any related capabilities can complement or enhance existing underwriting capabilities. Accordingly, some insurers are beginning to augment traditional due diligence processes (such as financial diligence, tax diligence and IT diligence) with underwriting-specific diligence to help ensure value realization over time. If a corporate development opportunity offers underwriting capabilities that at least align to—and preferably enhance—existing capabilities, it can help facilitate a smooth integration, thereby mitigating underwriting risk (a key cycle management consideration). Talent Management For the most part, commercial underwriting decisions cannot be fully automated because they require judgment. Therefore, it is natural for underwriting talent to be a top priority. However, insurance executives have lamented that it is a major challenge for the industry to attract and retain knowledgeable personnel. Two trends make commercial insurance talent management particularly challenging. First, experienced underwriters are leaving the industry. According to one study, “The number of employees aged 55 and over is 30% higher than any other industry—and that, coupled with retirements, means the industry needs to fill 400,000 positions by 2020.” Second, underwriting talent is relatively difficult to attract. For example, according to the Wall Street Journal, insurance ranks near the top of the list of least-desirable industries—according to recent graduates. The image of the insurance industry is that it is generally behind the times and offers little in terms of career development. Therefore, developing a performance-driven culture that enables the recruitment, development and retention of underwriting talent is more crucial than ever. To help accomplish this, insurers should employ and should continuously assess tools and resources that educate and empower underwriters through all phases of their careers. This is important because the expectations in commercial underwriting are high, and the nature of the job requires a diverse range of skills (e.g., analytical, relational, sales, financial and risk). Furthermore, the best commercial underwriters are entrepreneurial, which employers should highlight as they recruit and manage their underwriting staffs. Commercial insurers face a looming talent crunch and have to find ways to present themselves as—and actually be—a place where young people can have rewarding careers. Implications

• The relatively strong underwriting results of recent years are likely to soften in the coming year. Accordingly, commercial underwriters will need to accelerate their strategic efforts in:

1. Core systems and data quality,
2. New products, pricing discipline and terms and conditions,
3. Corporate development
4. Talent management

• Core systems transformations go beyond individual system competencies. To ensure timely, quality data across the entire commercial P&C value chain, insurers also are focusing on how the various systems are integrated with each another to facilitate the timely and efficient extraction and analysis of internal data and the focused and efficient use of external data (especially unstructured data).
• There are opportunities to create new products, but, to be profitable, insurers must exercise pricing discipline and must carefully and continuously track the adequacy of policy terms and conditions.
• Current surplus levels have enabled insurers to invest in corporate development, and some insurers have augmented traditional due diligence processes (such as financial diligence, tax diligence and IT diligence) with underwriting-specific diligence to help promote value realization over time.
• Commercial insurers have an aging workforce and are facing an impending talent crunch. Automation cannot replace the judgment that is required for effective underwriting. Therefore, it is vital for insurers to develop a performance-driven culture that enables the recruitment, development and retention of underwriting talent over time.