www.the-actuary.org.ukLqui eugait at accummod magnis alis nonsequat ut wisci eliquip euguerat prat.Stewart Mitchell discusses the pricing and rate monitoring challenges faced by insurers in a buyer8217s marketGoing soft8220Those who cannot remember the past are condemned to repeat it.8221 George Santayana, The Life of Reason, 1905-1906. The concept of the general insurance underwriting cycle has been around for some time and the more experienced readers will have been through both the hard, profitable parts of the cycle and the softer, less profitable or loss-making parts of the cycle. Given that the average cycle is thought to be around seven to eight years from peak to peak, some readers may have been through it several times.The softening market is top of the agenda for Lloyd8217s and the London Market. Lloyd8217s has identified the mitigation of the underwriting cycle as the single biggest challenge facing managing agents over the next few years. Unprofitable underwriting was reported to be a primary concern for every chief operating officer in a recent survey. The key to success will be an ability to make quick decisions based on capturing the right data and producing robust, reliable management information that provides early indicators of when rates are inadequate. So what issues should management be focusing on to mitigate the impact of the cycle? In answering this, it is useful to think of three distinct parts to the problem 8212 the pricing process, the rate monitoring process and controls around these processes. PricingThe general aim of the pricing process is to come up with a price or premium to be charged for a risk. This is usually based on some historic claims data projected forward to pay for the claims expected to arise from the exposure period for that risk.This premium will be made up of several elements aside from the expected claims costs, namely loadings for various other items including the volatility of claims, commissions, expenses, profit margin and contribution to capital costs.Terminology varies but let us call the price that will deliver the expected level of profit from the premium charged, to include the Stewart Mitchell is a senior manager within Ernst and Young8217s Insurance and Actuarial Advisory Services practice. The views expressed in this article are his personal views.elements described above, as the 8216technical price8217 (also known as the benchmark price). We introduce the concept of price adequacy, so we think of this technical price as 100% adequate.Recognising this minimum technical price is important so that profitability can be monitored without having to wait for the emergence of claims that may take several years. There is a difference, of course, between the actuarially calculated price and the price charged in the market, due to many competing issues. These are generally referred to as underwriting factors, including supply and demand pressures in the market. Relationship underwriting is also important whereby underwriters may write risks at less-than-adequate prices to maintain relationships for when the market hardens. There is a trade-off between maintaining customer relationships over the whole underwriting cycle and optimising short-term profitability.Further, it is difficult to ignore the pressure to write for market share and keep income levels up to at least meet fixed expenses, as rating levels drop off in the soft market. The collation of high quality rate monitoring information will allow management to monitor this fall in income with greater confidence. The technical price is only one of the factors the underwriter takes into account when deciding what price to charge. It is important, however, to understand the relationship between the price that should be charged and the price that is actually charged. In a hard market price adequacy will be greater than 100%, possibly significantly higher, leading to large profits. As the market softens, however, pricing adequacy will start to fall, perhaps below 100%, where the business may still be profitable but not commensurate with the risk taken. Further falls may lead to business being written at break-even levels, and can eventually lead to losses.The monitoring of the level of price adequacy leads us to the second part of the problem.Rate monitoring In the previous section we introduced the idea of price adequacy. Let us consider a risk written last year, which we considered to be 103% adequate, so making an additional profit beyond that which we expected to make, given the technical price.Insurance and reinsurance risks rarely give exactly the same risk profile year on year. Several changes may take place to alter the level of premium needed to maintain the same requisite level of price adequacy. These include changes in:n Premiumn Commission ratesInsuranceSoft market187 As the market softens, pricing adequacy will start to fall, perhaps below 100%, where the business may still be profitable but not commensurate with the risk taken 17138 March 2008038_039_Actuary_soft_0308.indd 3819/2/08 11:16:50
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