The London Insurance Market - PwC · the London Insurance Market under the spotlight, in particular its ability to deliver the consistent returns demanded by a new breed of capital

Sustaining the return to profitability

The London Insurance Market

Operational drivers in the London Market – a survey of insurers

Sustaining the return to profitabilityThe London Insurance Market

Operational drivers in the London Market – a survey of insurers

Contents

Introduction

Executive summary


5-12

13-32

49-50Contacts

Underwriting performance and cycle management

Claims service and claims cost management

Financial reporting

33-40

1-4

41-46

47-48

Introduction

Improved operational capabilities and effective cycle managementstrategies will be crucial in London Market insurers’ ability to steerthrough the choppier waters ahead.

The 12 months since our last surveyof the operational drivers in theLondon Insurance Market have seena significant return to profitabilityand a replenishment of capital lostin earlier years. Our 2003 surveyreveals that optimism remains high,with all respondents believing thattheir prospects for the year areeither broadly unchanged or set to get even better.

Participants are confident about therating prospects for their casualtybusiness, with rating increasesexpected to continue into 2004 inthe primary risks market. Someclasses of casualty business such asUS D&O could continue to hardenfor even longer. However, manyreport that the property and aviationunderwriting cycles have alreadyturned, with marine rates set tofollow the downward trend soonafter. Clearly, sustaining profitabilitywill be a challenge in a marketwhere the troughs in the ratingcycle have always tended to bedeeper than the rest of the global

insurance industry. Although allrespondents stress the importance of learning from the past by notfollowing the market down, manyadmit that one of the recurringweaknesses of the subscriptionmarket is that there always seems to be someone prepared to lead the slip, however unfavourable the rates and conditions.

Indeed, the nature of thesubscription market can create adegree of artificial ‘circular comfort’,as followers on a slip often looktowards the recognised marketleaders to identify when rates andterms become unacceptable. Leadersmeanwhile will consider the levelof support in the follow market as across-check on the acceptability ofrating levels for risks within certainparameters.

Why should we think that anythingwill be different this time around?For a start, the financialcircumstances have changed sincethe last downturn, with participantsrecognising that without the cushionof investment income there will belittle margin for error. At Lloyd’s, the new Franchise Board hasalready shown that it will intervene if performance falls below anacceptable level. Above all, many overseas capital providers, be they parent companies or short-term ‘quota share’ investors,have made it clear that they willwithdraw capacity if rates andreturns begin to fall away. While it will be easier for insurers to

‘2002 was about

seizing opportunities.

2003 is about

consolidation

and preparing for

cycle change.’Survey respondent

Sustaining the return to profitability • PricewaterhouseCoopers • p2

Introduction continued

withstand any pressure from brokers if their backers have already taken the decision out of their hands, some insurers are concerned that thisapproach may damage long-termrelationships. Furthermore, while there is no reason why independentorganisations cannot act with the samedecisiveness and discipline by ‘turningoff the tap’ when rates fall below asustainable level, they will need ahighly informed and determinedmanagement team to achieve this.

On the internal operational side, oursurvey reveals that many organisationsare making greater use of underwritingfile peer reviews, the development of pricing indices and sophisticated,technology-enabled aggregationmonitoring. These methodologies helpinsurers to regulate and improve riskselection, control exposures and trackrating movements at both a portfolioand market level. Most respondentsunderpin this with the application oftechnical pricing models for more thanhalf of their primary risks business,and for more than two-thirds of theirreinsurance business. These modelsallow insurers to evaluate marginsagainst a theoretical price and providea yardstick for the profitability of thebusiness. However, some others arereluctant to impose pricing or otherprescriptive guidelines in case thisstifles the flexibility and judgement of their underwriters. While this latterapproach may suit some organisations,the risks are arguably greater than withthe more systematic, and increasinglyprevalent, alternative.

As our survey underlines, there are many differences in the waycompanies are looking to strengthentheir operational capabilities andmanage their businesses through thecycle. However, our research hasenabled us to identify what we believeare likely to be the common attributesfor sustaining profitability:

• A clear focus on creatingshareholder value across theunderwriting cycle that isembedded within and wellunderstood across the organisation;

• A rigorous controls environmentaround the management ofexposures, the adequacy ofpremium rates and the quality of business accepted;

• Timely, reliable and focusedmanagement information;

• The ability to implement toughdecisions, particularly in relation to reducing volumes if acceptablepremium rates cannot be achieved;

• Investment in high quality people,at all levels, who are capable ofadapting rapidly and actingindependently of the ‘herd’ in a softening market; and

• Effective claims management tocontrol costs, minimise claimsleakage and provide high qualityclient service as a source ofcompetitive advantage.

p3 • Sustaining the return to profitability • PricewaterhouseCoopers

The coming pressure on rates willput the operational performance ofthe London Insurance Market underthe spotlight, in particular its abilityto deliver the consistent returnsdemanded by a new breed ofcapital providers. The findings ofthis survey offer some valuableinsights into whether the LondonMarket can rise to the challenge.

The research is based on in-depthquestionnaires and face-to-faceinterviews with executives fromboth Lloyd’s and Company Marketbusinesses, representing nearly 50%of Lloyd’s capacity in 2003 and acombined estimated gross premiumincome in excess of £11bn in 2003.As before, the participants wereselected to reflect a broad spectrumof entity sizes, product classes,independent businesses andsubsidiary organisations.

Our thanks go to all theorganisations and executives who participated in the survey, and without whose time this report would not be possible.


Executive summary

The latest PricewaterhouseCoopers survey of the operational driversfor insurers within the London Insurance Market is designed toupdate and provide more detailed analysis of the key themes thatemerged from our initial 2002 study.

The market remains buoyant,with three-quarters of participantsbelieving that their prospects areunchanged since 12 months agoand a quarter feeling that theyhave improved. Underwritingperformance and cyclemanagement, and managingaggregations of risk and theirimpact on results, continue to be the two key issues on thecorporate agenda.

In broad terms, the priorities placedon operational drivers are largelyunchanged from our 2002 survey.The only significant change relatesto the reduced level of importanceattached to InformationManagement, Systems and IT. This is likely to reflect, in part, the substantial IT projects in progressat the time of our last survey nowhaving been largely completed.

Capital management, includedexplicitly as an operational driverthis year, understandably featureshighly as a strategic imperative. The withdrawal of some capacity in 2003, together with the reductionin the level of capital which cantake the form of qualifying quotashare reinsurances to 10% withinthe Lloyd’s market, have put thespotlight firmly on managing theexpectations of investors as theunderwriting cycle starts to turn.


Regulation

Own credit rating versus market credit rating

Management of reinsurance programme performance


People

Capital management


Aggregations of exposure and impact on results

Cashflow and credit control

Information Management, Systems and IT

Investment performance

Cost control

Terms of trade

Distribution and sourcing of business

Not a priority Top priority

Subscription nature of London Market

Please grade the following operational drivers according to their importance to you in 2003

Source: PricewaterhouseCoopers 2003

‘Everyone in the

market is talking

about early

warning systems.’Survey respondent

Executive summary continued

Underwriting

Despite a softening in rates in somesegments, rates have some way to fallbefore they become unprofitable.Nonetheless, 50% of respondentsbelieve that ‘the top of the cycle is the optimum time to implement cyclemanagement strategies for the nextdownturn.’ However, judging whenthe cycle has reached its peak is farfrom straightforward.

Although the survey underlines theimportance of effective early warningsystems in being able to anticipate and respond to market trends, it alsosuggests that the level of confidence in such mechanisms is not as high asmost management teams would like.More than 50% of participants identify‘difficulties in determining when thecycle will turn or determining itsfuture shape’ as ‘significant or verysignificant barriers to effectiveunderwriting cycle managementwithin their organisation’. Over half of respondents also believe that‘difficulties in ensuring thatunderwriters adhere to and deliver the underwriting strategy’ could be a‘significant or very significant barrier’.

Many also recognise that unlike thelast downturn, they will not be able to offset the squeeze in marginsthrough investment income. Insteadthey will need to concentrate on thecore operational capabilities andcontrols needed to deliver a genuineunderwriting profit. Accordingly,

our survey highlights a renewed focus on strong gross underwritingperformance, the consistency of thisperformance over time and the qualityof the staff that underpin these results as the foremost underwritingmanagement priorities.

There are opposing views as to themost effective cycle managementstrategy, with a clear divide emergingbetween those respondents intendingto take an aggressive short-term stanceand those that prefer to take a long-term outlook on an acceptable level of return across the cycle. Surprisingly,however, only a third of respondentsbelieve that ‘maintaining brokerrelationships if exiting classes ofbusiness in a soft market’ will be a ‘significant barrier’, and noneconsidered this ‘a very significantbarrier’ in delivering their cyclemanagement strategies.

The clear message from respondents is that reducing volumes andimproving risk selection will be the‘most important actions in maximisingunderwriting performance in the next downturn’.

Many subsidiary organisations havealready been required to budget for acut back in volume and a withdrawalfrom non-core business to fit with theirgroups’ strategies. Independentorganisations not constrained in thisway by their capital providers will needto exercise greater discipline. As oneinterviewee pointed out, ‘many of the

‘You need a

mechanism that

spots when the

key points of the

risks and portfolios

are going the

wrong way.’Survey respondent


underwriters coming through nowdid not have authority to write inthe last downturn and therefore donot have the experience of tradingthrough the cycle.’

An average of around 50% ofprimary risks business by premiumvolume is now ‘rated according to documented technical pricing’,though even some advocatesrecognise that such pricing tools are more suited to some classes ofbusiness than others, such as motorand commercial property, and thatpricing will ultimately be driven bywhat the market will bear. Thissentiment is reflected in the factthat while pricing ranks as one ofthe most important underwritingprocesses/controls, the availabilityand use of pricing guidelines is only a moderate priority. A fewrespondents are clearly reluctant to impose prescriptive guidelines or statistical pricing models onunderwriters in case they underminetheir operational flexibility.

However, insurers can runsubstantial risks in not comparingmarket rates with technical prices,irrespective of the prevailing marketconditions. By using technicalpricing models, many organisationsbelieve that they are able to ‘draw aline in the sand’ to determine whento ‘turn the tap off’, estimate moreaccurately the shape of the cycleand therefore build a clear cyclemanagement strategy. They can also reduce the risk of rogue

underwriters and provide objectivetools to enable management tochallenge underwriters’ views. The latter argument is particularlypertinent for the remainder of 2003and the upcoming renewal season,as some underwriters may belooking to capitalise on ‘just onemore good year’.

To ensure that the quality of therisks accepted is in line with theunderwriting strategy, an average of 74% of primary risks and 84% ofinwards reinsurance risks are subjectto peer review/file audit each year.This represents a significantincrease on the level of rigourobserved in our previous survey.

Around two-thirds of respondentssay they will buy more reinsuranceas part of their cycle managementstrategy. More than 80% say thattheir evaluations of reinsuranceneeds are based on aggregationmonitoring, realistic disasterscenarios and a review of policyexposures, while three-quartersutilise frequency/severity modellingtechniques. Understandably, all ofthese techniques have becomeincreasingly sophisticated in theaftermath of 9/11.

Policy wordings continue to be amajor cause for concern, with somekey organisations strongly believingthat the market has not learnt itslessons from 9/11. Despite this,support for market initiatives such asthe LMP slip has been relatively poor.

‘I don’t care if we

have to cut out

three-quarters of our

current business to

sustain profitability

in the downturn.

It would prove that

we can put our

money where our

mouth is.’Survey respondent



The ‘recruitment and retention ofquality underwriting staff’ is again highon the list of important underwritingpriorities. Training is seen as the key to overcoming younger underwriters’lack of experience of writing in asoftening market, though many believethat the professional qualificationcurriculum needs to be more in linewith market needs or augmented by bespoke in-house programmes.Many participants also recognise that a key issue will be how to motivateand reward underwriters mosteffectively when volumes and returns begin to decline.

It is recognised that delegatedunderwriting authority arrangements(DUAs) can make it harder toimplement effective underwritingmanagement strategies. So why do so many London Market organisations,particularly in Lloyd’s, continue to givetheir pen away? For more than 75% of participants, DUAs represent anideal way to tap new markets and welldefined business niches, accountingfor an average of 23% of premiums in 2003. Nevertheless, most acceptthat safeguards and scrutiny could be improved.

Due diligence is now more robustwhen selecting a new DUA, thoughsome insurers’ assessments lack thesystematic structure and safeguards ofdocumented best practice procedures.Risk and pricing controls tend to bemore rigorous and comprehensive,with greater use of pricing guidelinesand less room for deviation from

these. While on-site file audits areused extensively as a key control, the effective management of DUAsdepends to a large extent on thequality and frequency of theinformation provided. The growingmove to electronic communication,now accounting for 48% of datasupplied, could eventually pave the wayfor the supply of real-time information,monitoring and interaction.

Claims management

Our last survey found claimslanguishing in what one respondentdescribed as a ‘black hole’. This year,claims service and claims costmanagement have effectivelymaintained their medium level priorityranking, despite claims being by far aninsurer’s most significant source ofoutgo. Claims handling policies andprocedures, as well as reservingtechniques, have been tightened upand formalised to some extent over thepast year, with 80% now following aclaims handling guide/proceduresmanual. However, the impetus for thisappears to have come at least in partfrom regulators and reinsurers, withinternal pressure for improvementsuffering from an overall lack of focuson costs in the current hard market.

It appears that this inertia stems in part from the practical constraints ofthe number of parties involved in the claims process, including brokers,outsourcers and service providers,especially in the Lloyd’s market,

‘Even on our most

extreme level

of delegation

we impose strict

rating guidelines.’Survey respondent

‘Organisations don’t

want to actively

manage claims,

it’s as if they let

them happen.’Survey respondent


despite widespread frustration with the quality of service andperformance. More than half ofrespondents believe that the qualityof claims broking has ‘deterioratedor significantly deteriorated’ overthe past ten years, and more than50% are dissatisfied with aspects of the central claims servicesprovided by XCS.

However, there are some notableexceptions among organisationsthat believe that claims service andclaims cost management representan important and largely untappedsource of competitive advantage,with one interviewee describingimproving the claims function ‘as an extension of the underwritingstrategy’. While business models for the claims function range fromfull outsourcing to the deploymentof largely in-house teams, the ‘best’ display the common virtues of tight control and proactive claims management. Part of thisimpetus appears to stem from therecruitment of a new breed ofclaims director.

One cornerstone of the emergingbest practice is the increasing levelof review/audit of open and closedfiles to identify weaknesses andoptimise claims processes andperformance. At the same time, the robust implementation of casestrategies that seek to achieve earlyresolution can improve clientsatisfaction, while delivering more

economic settlement levels andreducing the incidence of costlylitigation. Forward-thinkingorganisations are also looking at how to improve the status,incentivisation and careerdevelopment opportunities of their claims personnel.

Financial reporting

Our latest survey underlines againconcerns about the burden,usefulness and complexity offinancial reporting. Fewer than 50% of respondents express anymore than partial satisfaction withthe ‘process’ or ‘timeliness’ of theproduction of managementinformation. For external reporting,however, 90% are actively looking at how to reduce theirreporting times.

One of the keys to improvementappears to be greater use of ‘fast close’ techniques that enablecompanies to streamline reportingprocesses through the capture,warehousing and interrogation of core underwriting, claims andgeneral ledger data. Such anapproach has enabled onerespondent to cut the production of insurance results to 15 days(compared with a survey average of 48 days), giving their financeteam more time to focus onproviding information that canimprove decision-making and add value to the business.

‘The key to success

is being able to turn

data into information,

information into

knowledge and

knowledge into insight.’Survey respondent



However, reporting remainsexceptionally onerous in the Lloyd’smarket, with respondents preparing an average of 28 audited returns, inaddition to other regulatory reportingrequirements. The London Market will be strongly affected by the scaleand complexity of the move toInternational Financial ReportingStandards, which will exacerbate thedemands on already overstretchedfinance teams.



Back to basics

The business environment

Cycle management

Pricing and controls

Aggregations of risk and reinsurance

Distribution

People

All respondents recognise thatthey may need to cut volumes tosafeguard the bottom line oncerates begin to decline. The keyquestion is when and how to ‘turn off the tap’.

The businessenvironment

Certain segments have peaked.Premium rates in others are still rising.

The London Insurance Market is stillenjoying the best of times. Capacityhas grown on the back of a surge ofinvestment and demand. Althoughthe shadow of 9/11 remains, with a number of sizeable claims issuesstill to be resolved, the subsequentloss environment has beenremarkably benign. Above all, rates have increased strongly and in some classes, including US D&Oand other casualty business, haveyet to reach their peak. Thiscontinuing buoyancy is reflected in the fact that three-quarters ofrespondents believe that theprospects for their business in 2003are ‘broadly unchanged’ from 12 months ago and a significant25% are actually more optimistic.

Yet, this optimism is tempered by the realisation that premiumrates in some classes have alreadyreached their peak. Respondents’average projections for the propertypremium rating index suggestdeclines over 2004 and 2005.


‘The losses and

uncertainty in the

investment world

have focused people’s

attention back onto

making money

through underwriting

and understanding

underwriting as

a competency.’Survey respondent

‘Anyone can make

money in the current

market. However, the

next few years will be

far more challenging

and it will be

interesting to see how

the industry changes.’Survey respondent

80

90

100

110

120

2003 2004 2005

PropertyCasualtyMarine & Aviation

Prem

ium

Rat

ing

Inde

x

If the primary market premium rating index is normalised to 100 for the2002 underwriting year, what level do you expect the primary marketpremium rating index to be for the 2003, 2004 and 2005 underwriting years?


Underwriting performance and cycle management continued

Indeed, some interviewees are already reporting rating falls of up to 40% on some property business.Most also feel that aviation rates arebeginning to crumble, while formarine business the premium ratingindex is expected to decline over thecourse of 2004 and 2005 within theprimary market.

Although the average projected falls in the property reinsurance premiumrating index are slightly more markedthan in the primary market, most feelthat casualty reinsurance rates willincrease significantly in 2004 andstabilise in 2005. The buoyancy ofrating levels in the casualtyreinsurance market seems to bear out a number of respondents’ belief that‘reinsurers are going to be big driversin keeping some stability in the marketplace.’ Indeed, the possiblewithdrawal of some of London’s newUS-backed and Bermudan-backedcapacity, particularly in the guise ofqualifying quota share reinsurance,could help to bolster rates by bringing

supply back into line with demand.While our survey identified nooverriding driver of the underwritingcycle in the London Market,suggesting that movements areinfluenced by a number of relatedfactors, the incidence of catastrophes,competition and new entrants/exits are certainly seen as among the mostsignificant forces.

Nevertheless, London Market insurersare taking steps to achieve a softerlanding than in previous downturns, asall participants accept that poor equityreturns and the depletion of reservesfollowing 9/11 mean that there will bevery little cushion when rates do comedown. As one interviewee pointed out,‘the days when you could make areasonable return on equity at 115-120% combined ratios are longgone. Even the longest tail lines need to be combining at or below 100% to make a decent return. So thecommercial reality is that we need to get underwriting performance back at the top of the agenda.’


International competition

New entrants to the market/exits

Incidence of catastrophe losses

Competition within the London Market

Level of reinsurance premium rates

Market share objectives

Pricing commoditisation

Prior year deterioration in claims reserves

Pressure from brokers

Difficulties in determining underlying profitability

Not important Most important

Interest rates

Please grade by level of importance the factors that you consider to be key drivers of the underwriting cycle within theLondon Market


This renewed focus on strong grossunderwriting performance, theconsistency of this performanceover time and the quality of staffthat underpin these objectives arereflected in their rankings as theforemost underwriting priorities.Such factors as market share andlow expense ratios are secondary at best. As one interviewee said, ‘I can’t think of an insurer that’sbeen killed by an expense ratio,

though I can think of plenty thathave been killed by loss ratios.’

As would be expected, cyclemanagement is the number oneprocess/control in terms ofimportance to the organisation,closely followed by the corecompetencies of risk selection,pricing and management of riskaggregation. In contrast, businessnegotiation skills and the use of

pricing guidelines are seen as beingless crucial at present, though someinterviewees recognise that theymay become more valuable toinsurers as the pressure on ratesbegins to heighten.


Consistency of underwriting performance over time

Recruitment and retention of quality underwriting staff

Strong gross of reinsurance underwriting performance

Strong net of reinsurance underwriting performance

Production of reliable/timely management information

Top quartile/relative underwriting performance

Cost-effective reinsurance

Risk diversification

Low expense ratios


Market share

Please grade the following underwriting priorities according to their importance to your organisation


Performance measurement and monitoring

Underwriting authorities/licenses

Pricing

Risk aggregation management

Underwriting cycle management

Risk selection

Underwriting guidelines

Policy risk management

Portfolio management

Underwriting file audits

Pricing guidelines

Policy processing


Business negotiation

Please grade the following underwriting processes/controls according to their importance to your organisation



Cycle management

Many organisations face difficulties injudging when the market is about toturn and responding accordingly.

Nearly all respondents recognise thatbeing able to monitor and anticipatemovements in premium rates in atimely manner is crucial at this stageof the cycle, with most stepping uppeer reviews and the tracking ofpricing indices, terms and deductibles,and supporting this with regularprojections of emerging loss ratios.Others are looking to augment suchmonitoring with the use of the latestpricing and portfolio managementtools, to gauge their rating adequacythrough a comparison between theactual premiums charged and thetheoretical technical rates at both anindividual risk and portfolio level.

While such tools offer what somedescribe as a ‘line in the sand’ belowwhich they are reluctant to be drawn,pricing is, as we will see in the nextsection, still largely regarded as moreof an art than a science. As such,some question marks remain over the transparency and robustness of the pricing decisions that will be takenover the coming months. Indeed, even some of the strongest advocatesof technical pricing and portfoliomanagement techniques recognise thatthe successful tracking and projection of market trends, and the ability toidentify at what point to decline a risk, still ultimately depend on theexperience and judgement of seniorunderwriters. ‘It is the underwriter’s

job to monitor whether business isprofitable. You can have all the modelsand projections you like, but at theend of the day we have to trust theunderwriter to tell us where things are going’, noted one interviewee.

However, as a number of respondentshave noted, a subscription market can create a degree of artificial‘circular comfort’, as followers on aslip often look towards the recognisedmarket leaders to identify when ratesand terms become unacceptable.Meanwhile, leaders can view the level of support in the follow marketas a cross-check on the acceptabilityof rating levels for risks within certainparameters. Furthermore, it is moredifficult to control the potential for rogue underwriting when objective measures of premium rateadequacy are not readily available to management.

What is clear is that management and capital providers’ confidence in the efficacy of many of the earlywarning systems being used byLondon Market insurers is limited atbest, with around 50% of participantsidentifying ‘difficulties in determiningthe timing and shape of the downturn’as the main barrier to effective cycle management.

When asked about the best time to implement a strategy for a cycledownturn, 50% think it is ‘when therates are hardest’ and 25% ‘when ratesare between the top and the middle of the cycle’. Perhaps predictably, thefour main features of the action plan


‘The first to go is the

speculative business.

Write as much as

you can when the

market is hard and

pull out as quickly as

you can when the

rates fall off.’Survey respondent

underpinning the delivery of aneffective cycle management strategyare improving risk selection,reducing volumes, seeking tomaintain policy terms andconditions, and safeguardingpremium rating adequacy. Aroundtwo-thirds of respondents will alsobe looking to improve policy riskmanagement or to buy morereinsurance. However, barely athird of participants see cuttingcosts as a priority.

Many subsidiary organisations have already been required to build a cut back in volume and awithdrawal from non-core businessto fit in with their groups’ strategies. Will independent organisationshave the same discipline, or even in some cases the ability, to decline

business? ‘Difficulties in changingthe attitudes and behaviour of staff’are seen by 42% of respondents asa ‘significant’ or ‘very significant’barrier to cycle management.Indeed, one interviewee fears thatthe lessons of the past could beforgotten ‘in a loss of institutionalmemory’. He also pointed out that‘many of the underwriters comingthrough now did not have authorityto write in the last downturn and therefore do not have theexperience of trading through the cycle.’

As we will see later, many insurersnow recognise that the days when‘anyone could make money’ arenow coming to a close, and thatorganisations need to renew theirfocus on the quality, training and


‘Everyone in the

market is talking

about early warning,

looking at the risks

and spotting when

the market’s turning,

and yet I suspect five

years ago we were

saying exactly the

same things.’Survey respondent

64% 27%

92%

64% 36%

36% 64%

25% 67%

17% 50%

9% 55%

30% 60%

8% 75% 17%

36%

33%

8%

10%

9%

8%

100%

Risk management standards

Risk selection

Level of outwards reinsurance purchased

Flexibility of cost structure

Number of key producing brokers

Premium rating adequacy

Expense levels

Commission levels

Business volumes

Policy terms and conditions

0 100%

Increase/improveMaintainReduce/relax

Which of the following underwriting and related actions will your organisation use to maximise underwritingperformance in the next underwriting cycle downturn?



supervision of frontline underwriters.‘Underwriters are going to have to beat the top of their game to know whatbusiness to take and what to reject.Supplying them with up-to-dateinformation will be crucial,’ said oneinterviewee. Above all, ‘turning off the tap’ seems to be a question ofnerve. ‘We need to be bold enough to say we will not write it,’ saidanother interviewee.

In deciding what business to discardand what to retain, almost all

respondents stress the need to cutback on the opportunistic andspeculative ‘punts’ – which tend to be relatively less risky in a very hardmarket – and concentrate on core lines and customers, ‘where we havethe necessary expertise, relationshipsand client data’. Many intervieweesalso believe that ‘spending on the support infrastructure is even more important in a soft market’, in particular the effectivebroker/customer relationshipmanagement needed to attract and


Increase in expense ratio due to lower premium volumes

Difficulties in monitoring the key drivers of the underwriting cycle

Difficulties in sustaining broker relationships if exiting classes of business in a soft market

Difficulties in achieving effective performance measurement

Difficulties in quantifying the relationship between premium rate adequacy versus business volumes

Difficulties in determining/monitoring premium rate adequacy

Difficulties in determining future outwards reinsurance costs

Difficulties in ensuring that underwriters adhere to and deliver the underwriting cycle management strategy

Difficulties in determining when the underwriting cycle will turn

Difficulties in determining the shape of the future underwriting cycle

Difficulties in determining robust exposure measures

Heterogeneous nature of business portfolio

Difficulties in changing the attitudes and behaviours of staff

Difficulties in measuring own performance versus market performance

Difficulties in identifying the key drivers of the underwriting cycle

High frictional costs (e.g. acquisition costs) in moving into new segments/markets

Not a barrier Very significant barrier

Limited access to market intelligence

Please grade by level of importance the main barriers you perceive to an effective underwriting cycle managementstrategy within your organisation


retain business. However, only athird of respondents believe that‘difficulties in sustaining brokerrelationships if exiting classes of business in a soft market’ arelikely to be a significant barrier to effective cycle management.

Many believe that foresight andproactive management in dealingwith brokers can help to avoidrancour, for instance ‘cutting ourline on a slip from 40% to 20% in one year, and then declining thepolicy altogether when the rateshave come right down, is likely to be far less damaging to therelationship than a one-off refusal,’said one interviewee. Somerespondents also believe thatgradually ceasing to be a leader onslips, in addition to reducing linesizes, during the start of the cycledownturn can provide greateroperational flexibility when activelyseeking to reduce business volumes.

There is a divergence of philosophyregarding short-term results andreturns across the cycle, whichexternal analysts often do not give enough weight to. Somerespondents say that they will beprepared to write core classes ofbusiness at an acceptable level ofloss in a softening market as part ofan overall strategy that sets returnon equity targets across the cycle.Where desire for a high level ofrenewals or the need for followingmarket support on a slip is less ofan issue, it is easier to price andexit classes of business on a risk

by risk and year by year basis. This particular approach fits in wellwith the mobile capital strategies of some of the larger overseasinvestors, particularly thoseproviding support in the form ofqualifying quota share reinsurance.

Pricing and controls

Views differ on the best way to set prices and exercise effectivecontrol of underwriting quality.

An average of 51% of respondents’primary risks and 69% of inwardsreinsurance business are ‘ratedaccording to documented technicalpricing’. The application ofdocumented legacy rates is the most common pricing approach forprimary risks, whereas statisticalexperience-based rating models aremost extensively used in the pricingof reinsurance business. A variety of components such as trendedburning costs and frequency andseverity distributions are included in these rating models, although a profit/return on capital andreinsurance cost elements are farless commonplace. What is clear isthat there are a variety of definitionsof the term ‘technical pricing’ beingused across the market.

Those respondents setting pricingguidelines generally allow a degree of latitude both above andbelow the technical rate to giveunderwriters the scope for flexibility,with the underlying rating models

‘We want to

understand what

customers value from

insurance and we

want to use superior

insights in risk to

provide solutions to

customers that will

help us to mitigate

the costs of managing

the cycle.’Survey respondent

‘Technical pricing is

not where it needs to

be. Large parts of the

direct market base

their prices on opaque

rating models that are

literally straight off the

back of a fag packet.’Survey respondent



most commonly being validated usingpricing peer reviews and monitoring of actual profitability.

Establishing such models can bedifficult for new entrants who tend to lack the necessary historical data.Participants also stress that some risksare more suited than others to suchpricing techniques. For instance, itwould be virtually impossible to rateterrorism risks in this way, and onerespondent ultimately believes that‘85% of the price is market driven’.Equally, the quality of informationprovided by brokers and corporate risk managers is only as good as theinterpretational skills and insight of the people who use it.

However, what did emerge from oursurvey is that while participants thatuse technical pricing accept itslimitations, they believe that it permitsthem to operate in a more secureenvironment than competitors that do not. In particular, it enables themto track the market cycle and ratingadequacy more accurately and moretransparently, while enhancing thefocus on profitability at the point ofsale. While some interviewees believe

that the use of such models is likely toincrease as market rating levels movecloser to a break-even position, thereis also the very real risk that technicalpricing will be discarded by thoseunderwriters who maintain that priceswill ultimately be driven by what themarket will bear.

Insurers can run substantial risks in notcomparing market rates with technicalprices, irrespective of the prevailingmarket conditions. For example, anumber of respondents have come tothe conclusion that marine rates incertain segments are still significantlybelow a break-even level, despite theoverall hardening of the market. Byusing technical pricing models, manyorganisations believe that they areable to estimate more accurately theshape of the cycle and therefore build a clear cycle management strategy,and provide objective tools formanagement to be able to challengeunderwriters’ views. The latterargument is particularly pertinent for the remainder of 2003 and theupcoming renewal season, as someunderwriters may be looking tocapitalise on ‘just one more good year’.

To ensure that the quality of the risks accepted is in line with theunderwriting strategy, an average of74% of primary risks and 84% ofinwards reinsurance risks are subjectto peer review/file audit each year.Although several insurers go so far as to peer review 100% of their risks,over 90% of respondents consider thecurrent level of underwriting file auditsto be sufficient. This represents asignificant increase in the level of


0 100%Less than 30%30% – 70%More than 70%

Primary risks

Inwards reinsurance

20%20% 60%

13% 13% 74%

What percentage of risks/underwriting files (by gross premium volume) arepeer reviewed/audited per annum?


‘The more granular we

can get our pricing

and the better we

listen to and

understand our

customers’ risk

management strategy,

the happier they are.’Survey respondent

rigour observed in our previoussurvey. In addition, over two-thirds of respondents measureunderwriting performance at theindividual underwriter level.

The rigour and sophistication ofunderwriting controls have certainlycome a long way since the wake up call of 9/11.

Some also doubt how effectivelypricing models and guidelines are passed on to and used byunderwriters. For example,

relatively high percentage deviations from the technical price(up to 20% below this in somecases) are permitted by somerespondents. Ultimately, manyinterviewees recognise that it is notalways possible or even practical toensure that underwriters adhere toprescriptive guidelines. As we foundin our last survey, this is essentiallya corporate cultural issue, thoughmany respondents believe thatregulatory and market pressurescould mean that underwriters willnow have to accept a tighter rein.


50%

100%

33%

50%

42% 58%

33%

33%

67%

67%

8% 92%

17% 83%

83%

67%

17%

Class level

Sub-class level

Underwriter level

Business segment/trade

Broker level

Underwriting branch/office level

Cedant level

Territory level

Other

0 100%

YesNo

At which of the following levels do you monitor your underwriting performance?


Monitoring of profitability

Pricing peer reviews

Monitoring of volumes and mix of business

Monitoring of actual prices vs technical prices

Pricing file audits

Underwriting/pricing committees

Monitoring of quotation acceptances


Comparisons against competitors

Please grade the following mechanisms which you use regularly to ensure that your pricing process is working effectively



Nonetheless, all respondents doappear to use underwriting manuals/guidelines in some guise. These tendto focus mainly on permissible limitsof cover, aggregations of risk and anyassociated outwards reinsurancerequirements. With regard to riskselection, however, over 70% ofparticipants have no documentedguidelines, with underwriters preferring to rely on their experience.

Accordingly, a key challenge for theLondon Market in the cycle downturnwill be how to strike the right balancebetween providing underwriters withsufficient flexibility to apply theirjudgement, while maintainingsufficiently tight control to deliver the underwriting strategy. As a result,

all respondents issue their underwriterswith individual authority limits/licences,and use regular underwriters’ meetingsas a forum for highlighting emergingissues and specific risk areas.

However, there are some warningsigns that these controls may not go farenough in the downturn. For example,the documented risk selection andunderwriting guidelines tend to be lessuniform across participants in relationto the inclusion of businesssegment/trade, location and the leveland quality of quotation information.To strengthen underwriting controls inpreparation for the downturn, variousbehavioural and cultural issues willalso need to be managed as part of an overall change programme.


50% 50%

90% 10%

80% 20%

56% 44%

50% 40%

40% 50%

30% 70%

30% 60%

40% 50%

20% 70% 10%

10%

10%

10%

10%

10%

90%

Policy wording

Territory

Location

Size of risk

Aggregation of risk

Outwards reinsurance requirements

Level/quality of quotation information

Historical claims experience

Business segment/trade

Quality of insured’s management

Moral hazard

0 100%

Considered and guidelines are documentedConsidered but not documentedNot considered

Please grade the extent to which your primary risk selection and underwriting manuals/guidelines cover each of theaspects set out below


Policy wordings continue to be amajor cause for concern, with someorganisations strongly believing thatthe market has not learnt its lessonsfrom 9/11. The cycle downturncould exacerbate the problem asterms and conditions are put underincreasing pressure. While manyaccept the need for some form ofstandardised interim wordings toreduce the potential for disputesbefore final contracts are agreed,support for market initiatives suchas the LMP slip has been relativelypoor. Significantly, only half ofrespondents set any guidelines onpolicy wordings. Some respondedthat they believe this area to be thepreserve of the broker.

Aggregations of riskand reinsurance

Managing aggregations of risk and their impact on resultscontinues to be the second most important issue on thecorporate agenda.

More than 80% of respondents saythat the main reasons behind theirreinsurance purchasing strategy in2003 are to seek cover againstcatastrophe events and aggregationsof risk. Aggregations of risk aremonitored in increasinglysophisticated ways that combineoff-the-shelf software tools andbespoke technology. These toolsallow aggregations to be monitoredaccording to states/counties,country/region and ZIPcode/postcode by more than 80%of respondents, and two-thirds ofrespondents monitor exposures byclass of business. These tools havealso led to more widespreadassessment of aggregate exposuresprior to the acceptance both ofrenewals and new business (asdisplayed on the chart on page 26),though only a third of respondentsrecord the aggregations forindividual insureds. Aggregationlimits are most commonly set aspart of the business planning cycleand in the determination ofreinsurance requirements.

‘Wordings scare

the hell out of me.

The industry needs

to be a lot more

professional on

this issue.’Survey respondent


Protect against aggregations of risk

Improve ability to write larger risks

Protect against catastrophe events

Improve capacity

Improve net profitability

Smooth underwriting performance

Protect solvency margin

Improve balance sheet strength

Access to reinsurers’ expertise


Improve solvency margin

Please grade the following reasons behind the purchasing/structuring of your 2003 reinsurance programme



Although around two-thirds ofrespondents say they will buy morereinsurance as part of their cyclemanagement strategy, only around40% of participants cite the use ofreinsurance as a top or high priority in protecting their solvency margin.More than 90% of participants say that their evaluations of reinsuranceneeds are based on aggregationmonitoring, realistic disaster scenariosand a review of the largest policyexposures, while over three-quarters

utilise frequency/severity modellingtechniques. Understandably, thesetechniques have become increasinglysophisticated in the aftermath of 9/11.Perhaps surprisingly, only 45% basetheir reinsurance purchasing decisionson capital/solvency modelling. Insurerswill need to consider whether theirmodelling capabilities can carry outthe stress and scenario testing requiredunder the Integrated PrudentialSourcebook (PSB).


67% 33%

92% 8%

83% 17%

83% 17%

33% 67%

33% 67%

33% 67%

33% 67%

Class of business

Business segment/Trade

Underlying insured

Country/Region of world

States/Counties

ZIP Code/Postcode

Individual cedant

Individual broker

0 100%

YesNo

Which of the following aggregations of risk are monitored?


73%

18%

27%

64% 36%

27%

18%

73%

82%

8% 92%

9% 91%

82%Explicit limits are set out in the business planIn conjunction with determining

outwards reinsurance requirements

Via explicit agreement with capital providers/parent

Via capital/solvency modelling

Legacy aggregate exposure limits are adopted

Other

No aggregate limits set

0 100%

YesNo

Which of the following do you use to set your aggregate exposure limits?


As we outlined in our 2002 survey,there has been a flight to qualityreinsurers in recent years, despitethe widespread number of creditdowngradings leaving only oneAAA-rated reinsurer, which hastended to raise costs. As manyparticipants believe that reinsurancerates will prove to be moresustainable than premium levels inthe primary market over the nextfew years, these already high pricescould become an additional burdenover the cycle downturn. There arealready indications from our surveythat this is likely to lead to anotherstrategic re-think about howorganisations buy and applyreinsurance, especially as around40% of participants complain that‘the frequency and use of spurioustechnical defences by reinsurers isincreasing’ (see the Claims section).There are also some concerns thatthe concentration of the reinsurancemarket into a few highly ratedplayers could present its own risks.

Distribution

Some argue that binders are the‘lifeblood’ of the market. Othersbelieve that the risks still outweighthe returns.

London remains the world’s premiercentre for insuring speciality risks.As one interviewee remarked, ‘our parent company is amazed at the business that comes here that they wouldn’t otherwise see.’ Yet, a number of respondents arelooking beyond their traditionalLondon-based business to branchout into Bermuda, ContinentalEurope and other overseasterritories. ‘There is a market for our specialist expertise beyondLondon... we’re not looking to cutout the London Market broker, onlysome of our new clients in Europeare not prepared to pay theadditional commission,’ said one interviewee.

‘A delegated authority

is an effective way

of leveraging our

resources. We can

get business in markets

we would never have

access to otherwise.’Survey respondent


75% 25%

75% 25%

75% 25%

58% 42%

42% 58%

Pre-acquisition of new business

Pre-renewal of existing business

Periodic reviews

At renewal of outwards reinsurance protections

Post catastrophe/event losses

0 100%

YesNo

When are aggregations of risk typically assessed/monitored?



However, most participants recognisethat their core business is in Londonand that brokers are their keydistribution channel. It is significantthat distribution and the subscriptionnature of the London Market areamong the lowest operationalpriorities, reflecting in part whatinsurers privately accept is a lack ofinfluence over the supply of business.

Delegated underwriting authorityarrangements (DUAs) are used by 75% of respondents, with sucharrangements set to make up anaverage of 23% of their premiumincome in 2003, which is largelyunchanged from last year. DUAbusiness represents between 3% and30% of such respondents’ total grosspremium income, though in somecases organisations do not actuallygive away their ‘pen’ as the rates and wordings are set in London.

This issue generated a lively debate inthe interviews. ‘Binders no longer offeran easy income. Controlling them isan administrative nightmare, especiallynow regulation is tightening up,’ saidone participant. Yet, for three-quartersof those surveyed, DUAs represent anideal way to tap new markets and welldefined business niches. ‘Delegatedauthority is the lifeblood of Lloyd’s,’said one interviewee. ‘Our name andpresence in the US and other overseasmarkets have largely been establishedon the back of such relationships,’ saidanother respondent.

Nevertheless, most accept thatsafeguards and the level of scrutiny forsuch arrangements could be improved.Over 44% of participants do now‘consider and document’ the keystrategic factors for selecting a newDUA, which focus on businesssegment/niche, access to new markets,market expertise and the claims history.


56% 44%

44% 56%

44% 56%

33% 67%

33% 56%

44% 56%

22% 67% 11%

11%

86%14%

Well defined business segment/niche

Growth potential/access to new markets

Claims history

Market expertise

Strategic alignment

Level/quality of quotation information

Portfolio diversification

Exclusivity arrangements with business provider

0 100%

Considered and guidelines are documentedConsidered but not documentedNot considered

Please grade the following strategic factors included in the consideration of a new DUA


The majority of respondents‘consider and document’ thequality/experience of the keypersonnel, while just over 50%‘consider and document’ thefinancial security, the underwritingcompetence, past performance, the quality of the policy and claimsinformation, and the quality of theDUA controls environment offeredby these third parties. While the restdo tend to consider such factors,their assessments lack the systematic structure and safeguardsof documented best practiceprocedures. Just over a third ofrespondents review internal auditfiles when assessing a new DUA,and less than a third seek referencesfrom previous capital providers.Surprisingly, of those participantsthat use standard agreements, two-thirds fail to include non-performance remedies.

Risk and pricing controls havetended to become more rigorousand comprehensive in the light ofsome well-documented problems.This includes greater use of pricingguidelines with limited scope fordeviation. Nearly 90% ofrespondents’ DUAs have beensubject to on-site file audits in thepast three years, though less than a half have been subject to this inthe past 12 months, reflecting thedifficulty in achieving annual audits of a large and geographicallydiverse portfolio of DUAs.

The effective management of DUAsdepends to a large extent on the

quality and frequency of informationprovided. Premium, risk and claimsinformation is supplied on amonthly basis by around two-thirdsof DUAs and quarterly by about athird, resulting in a potentially largelag in the ability to ‘turn off the tap’should the emerging profitabilityprove to be unacceptable. Therewere relatively few instances ofrespondents receiving data moreregularly than this, and theprovision of data on an annual basis has yet to die out completely.

The findings on the extent of auditsand the timeliness of the provisionof information do underline thestretched lines of governance inoperation. However, electroniccommunication, described by one interviewee as a potentialrevolution in the control of DUAbusiness, now accounts for 48% ofdata supplied, and could eventuallypave the way for the supply of real-time information, monitoringand interaction. Lloyd’s has alreadyintroduced an internet-basedcoverholder registration system,with more developments to follow.

While such innovations cancontribute to an improvement inbest practice, many respondentsrecognise that these and otherinitiatives are adding to theadministrative burden of DUAs. As a result, many now believe that a 25% line on the slip is the realisticminimum for the cost-effectivemanagement of binders, lineslipsand other third party arrangements.


47%48%

1% 1%3%

Electronic spreadsheet submitted by emailPaper bordereauxData download from mainframe systemReal-time, direct interfaceOther

What is the proportion of data (bynumber of DUAs in force) providedin each of the following formats?


65%

32%

1% 2%

Half yearly/AnnuallyQuarterlyMonthlyDaily/Weekly

What is the proportion of data (by number of DUAs in force) provided according to each of the following frequencies?



People

The value of people will grow in a softening market. Is the market investing enough in thiscritical resource?

Overall, ‘people’ are the third mostimportant operational driver in oursurvey, with 83% of respondentsranking their staff as either a ‘top’ or ‘high’ priority. The vital role ofunderwriters in the organisation can be seen in the fact that the‘recruitment and retention of qualityunderwriting staff’ is seen as the thirdmost important underwriting priority,with 90% of respondents giving it a‘top’ or ‘high’ priority ranking.

The reputation, and by implication the success, of the organisation is themost crucial factor in securing the rightpeople, with 83% of participants givingit a ‘top’ priority ranking. This is closelyfollowed by the opportunity to share inthe profits. Average underwriting staffturnover was 8% in 2002, in line withthe ratio deemed to be acceptable. This masks the fact that the individuallevels of staff turnover ranged from 0%

to 25% in 2002, with around 60% of respondents citing the ‘closure ofnon-core lines of business’ and around35% the ‘high marketability of goodquality underwriters’ as the mainreasons. Nevertheless, the rate of staffturnover has slowed down.

In seeking to maximise underwritingstaff retention, an average of 60% ofremuneration is fixed and 40% variableif 2003 proves to be a ‘good year’, with‘combined ratio (excluding IBNR)’ used,in part, to set performance-related payby some 60% of respondents, closelyfollowed by the underwriting resultand the insurance result as keymetrics. Gross written premium is only used by one participant as adriver of performance-related pay,which provides a degree of comfortthat many London Market insurershave started to put in place moreappropriate remuneration strategies in advance of the cycle downturn.

How to adjust these bonuses to reflectthe more controlled and targetedunderwriting required in a softeningmarket is a key issue. ‘It is easy to becomplacent about people in a hard

‘A business is only as

good as its frontline

underwriters.’Survey respondent


Reputation of the organisation

Sharing in the profits of the organisation

Level of basic remuneration

Career progression opportunities

Long-term benefits (e.g. pensions etc.)

Other forms of recognition of contribution to the organisation

Quality of training programme

Status/title

Not important Most important

Short-term benefits

Please grade the importance of the following factors in attracting and retaining the right underwriters for your organisation


market,’ said one respondent. ‘In asoft market the quality of your peopleis crucial.’ Indeed, underwritingstaff may be reluctant to scale back business volumes for fear thattheir jobs or status both in theorganisation or in the external marketcould be in jeopardy. ‘We need tomake sure our staff realise that weare prepared to pay them to writevery little business if that is what isneeded,’ said one interviewee.

Training is recognised as playing animportant part in equipping theyounger underwriters with the skillsthey need to operate in what couldbe a far more taxing environmentthan they have experienced up untilnow. While more than 90% of

respondents conduct a performanceappraisal at least once a year,around a third of participants donot have a formalised trainingprogramme, a lack of investment in people that could prove costly in the long run, particularly in acycle downturn.

An average of 30% of participants’underwriters are professionallyqualified, with an additional 25% of underwriting staff currentlystudying for exams. Further impetusis likely to come from the FSA’s new‘competency’ rules. However, somerespondents question whether themain professional qualificationsavailable today offer the requiredrange of skills.


0 100%Less than 10%10% – 20%More than 30%

2001Year

2000

2002 27%64% 9%

45% 55%

40% 40% 20%

What level of underwriting staff (excluding policy administration/processingroles) turnover have you experienced over the last three years?


0 100%

YesNo

92%

67%

8%

33%

8% 92%

67% 33%

Performance appraisal

Career development planning

Formalised training programme

None

Which of the following are undertaken at least annually for every member of the underwriting department?



Some three-quarters of participantsaugment professional training withstructured in-house programmes, with around 78% including a focus on pricing in the tuition. However,only 56% cover risk selection and44% cover measuring the aggregationof risk. Hardly any touch on claimsmanagement and financial reporting.These results indicate that thereappears to be significant gaps ininsurers’ technical trainingprogrammes, when these shortfalls are considered against respondents’key operational drivers andunderwriting management priorities.‘The market

benchmark for

technical training in

our industry is weak.’Survey respondent


78% 22%

67%

67%

44%

33%

33%

56%

56%

44%

44%

44%

56%

56%

67%

22% 78%

22%

11%

78%

89%

25% 75%

33% 67%

44%

44%

56%

56%

33%

Pricing

Underwriting guidelines

Risk management

Risk selection

Business negotiation

Aggregation of risk

Portfolio management

Market trends/issues

Outwards reinsurance

Marketing

Claims management

Financial reporting

IT/Systems

Other

No structured training programme is in place

0 100%

YesNo

Which of the following aspects are included in a structured training programme for underwriting staff within your organisation?



Staking a claim

Processes and controls

Reinsurance recoveries & salvage & subrogation

Service providers

Outsourcing

Performance management

People

Claims management has long beenthe poor relation of underwriting.Could high quality claims serviceand effective claims costmanagement now be gaining the recognition they deserve?

Processes and controls

Claims processes and controls areimproving, though from a low level.

As we outlined last year, the lowpriority afforded to claims partlyreflects the perceived lack of control over claims arising from thesubscription nature of the LondonMarket. As one interviewee in thelatest survey ruefully admitted,‘sometimes we pay claims thatmaybe we shouldn’t just to keep thebroker happy.’ Others are reluctant to be followers on a slip largely forthese reasons. Few respondentsreckon that the quality of claimsbroking has improved following the consolidation of the brokermarket over the past decade, with more than half believing that it has ‘deteriorated’ or‘significantly deteriorated’.

The key areas where respondentsbelieve that brokers could ‘addmost value’ to the claims processand where their performance couldbe most improved include brokingnew claims, the collection of

‘I think the whole

industry needs to

wake up and focus

on claims.’Survey respondent


Broking new claims/updates in a timely fashion to the relevant insurers/reinsurers

Chasing service providers/policyholders for updated information

Timeliness of updating case reserves and identifying redundant case reserves on CLASS

Collection of reinsurance recoveries from the market

Collection of claims monies/fees from the market

The handling of claims, if a delegated authority is granted

The instruction of service providers

Involvement if there are coverage issues

Involvement if there are quantum of claim issues


Checking coverage on the submission of a new claim by the policyholder

If brokers could improve their performance in any of the above areas, which would you choose? Please grade thefollowing areas


Claims service and claims cost management continued

reinsurance recoveries, chasing serviceproviders/policyholders for information,improving the speed of updating casereserves and identifying redundantcase reserves on CLASS.

However, some of the organisationswe surveyed are now laying thefoundations for more controlled andeffective claims management. Some80% of respondents now follow aclaims handling guide or proceduresmanual, and most of these organisationsupdate this between once and fourtimes a year. Nearly all respondentsapply individual authority limits forsettlement, and close to three-quartersimpose these for case reserving andclaims payment authorisation.

Partly in response to FSA concernsabout the lack of documentationidentified in its Arrow visits, three-quarters of respondents now follow setprocesses/guidelines for the ‘reservingof new claims’ and the ‘review andthe closing of inactive/redundantclaims’. However, only around aquarter apply such systematicprocedures to the ‘use of nominalreserves’ and only a half have adocumented case reserving philosophy.

Around three-quarters of participantsnow insist that their own claimspeople step in if they are dissatisfiedwith the ‘lead’s claims handlingcompetence’, reflecting the moreproactive stance being taken by some of the more forward-thinkingorganisations in this field. The impetusto ‘take best practice to the next level’can also be seen in the greater use ofpeer reviews, with an average of 35%

of all open claims now subject to suchscrutiny each year. Some organisationswill even review up to 100% of theiropen claims files in striving to achieveclaims excellence. The main criteriaassessed are reserving accuracy, theapplication of technical skills and theproactivity of the claims handler inseeking to reach early settlement.Some insurers also review up to 20%of their closed claims files each year,with the level of claims leakageincluded as one of the key areas offocus. Minimising claims leakage islikely to prove increasingly critical in the next cycle downturn.

Some participants have extended thisprogramme of review still further, with around half the respondentstaking part in some form of cedantreview or opening up their own filesto external audit or inspection byclaims or internal audit staff fromanother part of the group. For some,the ultimate aim is the integration ofclaims management into the overallframework of underwriting and pricingcontrol cycles and value creation.‘Claims and underwriting feed off eachother. It is crazy not to have input fromclaims into wording and pricing,’noted one interviewee.

However, the overall controlsenvironment remains patchy, with oneor two respondents believing that mostclaims departments are simply toosmall and overstretched to maintainproper safeguards. A good example of this is the low priority afforded toinsurance fraud, which those thatreplied estimate as relating solely topolicyholders or third parties and


accounting for only an average of4% of total claims costs. While thiscompares favourably with the levelsof fraud estimated by the Associationof British Insurers for the UKinsurance industry as a whole, thesurvey highlights that there are fewprocedures in place to identify ordeal with potential fraud, or indeedto evaluate the effectiveness ofthese limited controls.

Reinsurance recoveries& salvage & subrogation

Could a lack of automation meanthat organisations are missingopportunities for recoveries?

The key focus continues to be largelosses, with nearly all participantshaving procedures in place for theinvestigation and reserving of theclaim, and for the subsequentidentification and notification ofoutward reinsurance recoveries.Indeed, the hardening of reinsurers’attitudes to primary insurers’ claimsprocedures appears to have beenone of the main spurs forimprovement. When asked ‘whatstatements reflect your view of thecurrent state of claims activity in the reinsurance market’, around50% of respondents said that they‘agree’ or ‘strongly agree’ that ‘thequantum and the coverage aresubject to increased levels ofscrutiny by reinsurers.’

Many participants also recognise the potential for improvingreinsurance recoveries and

salvage/subrogation levels. ‘We are coming to the point whenour reinsurance recovery is about to hit a peak and our claims focusis on that,’ said one interviewee.However, our survey once againfound a wide variation inprocedures. Only half therespondents deploy automatedsystems to identify potentialreinsurance recoveries and to track their progress. Even fewerparticipants have automated theidentification and tracking ofrecoveries from salvage andsubrogation. With salvage andsubrogation representing an average of 6% of gross claims costs where respondents were able to quantify these, this could meanthat they are missing out onvaluable opportunities.

Service providers

How do organisations knowwhether they are getting value for money or not?

There are concerns that the London Market spends too much on external service providers,especially lawyers, and gets toolittle in return. Indeed, one or two respondents complain thatoverstretched slip leaders arepassing on the handling of claims to their legal advisors, which is‘profligate in the extreme’.However, few participants measurethe performance or costeffectiveness of their legal advisorsin a structured way, though most

‘The big reinsurers

aren’t rolling over any

more; even if it’s a

valid claim, they’ll

go through the

motions. It’s not being

obstructive, just a little

more tortuous –

they would call it

more disciplined.’Survey respondent



have queried an average of around 7% of their invoices by value over the past year. ‘If they don’t check, how will they know that they are notpaying fancy senior lawyer rates forsome junior to actually do the work?’said one interviewee.

There are clear opportunities forrationalisation and cost saving. Indeed, some insurers are now hiringtheir own in-house legal teams or evenputting senior legal counsel in chargeof the claims departments. Closed filereviews enable participants to judgewhether the fees were justified orwhether hiring/using an in-houselawyer might have been more costeffective. Another solution might bethe increased use of alternative dispute resolutions at an earlier stage, potentially saving all partiesconcerned significant time and costs.

Most participants also believe that the quality of loss adjustors could beimproved, especially overseas. Manychoose to hire UK-based personnel tohandle losses irrespective of territoryand jurisdiction, as they are perceivedto have superior technical knowledgeand a better understanding of therequirements of the London Marketthan their local counterparts.

Outsourcing

Satisfaction with outsourcers is weak,yet organisations do little to spurimproved performance.

Our 2003 survey highlights growingdissatisfaction with the quality andservice provided by claimsoutsourcers, including more than halfof those who use Xchanging ClaimsServices (up from 25% last year). Most


29%

43%

71%

43%

71%

14%

57%

29%

57%

57%

14% 86%

14%

14%

86%

86%

22% 78%

14% 86%

57%

43%

43%

86%Quality and timeliness of information provided

Proactivity of approach to claims handling

Reduction in processing error rates

Quality of technical decisions

Processing efficiencies

Technology-enabled data exchange

Level of responsiveness to queries/challenges raised

Costs/Cost control

Level of commercial awareness in decision-making

Other

None

Not applicable

0 100%

YesNo

In which particular area(s), if any, are you looking for XCS to improve the level of claims service currently provided?


would like XCS to reduce the levelof errors, provide a more proactiveapproach to claims handling andimprove the quality and timelinessof information. Nonetheless, one respondent told us ‘XCS is aprocessing function that is wakingup to the fact that it could be areally useful service provider andearn more money as a result.’ It should also be noted that theperformance of other outsourcedservice providers did little toencourage insurers to extend the use of third party claimsarrangements in the future. Indeed, some organisations will notdelegate lead claims responsibilitiesas part of their belief that it is wrong to ‘outsource what is a corecompetency and a core priority’.

Yet, a majority of respondentscontinue to contract out at leastsome of their claims handling to aservice provider, with the averageclaims volume being outsourced ataround a quarter of total claims bynumber. Most base their decision tooutsource claims handling on the

class of business in question, thespecific technical competence ofthe service provider and on thevolume of claims/lack of economiesof scale in-house. Those thatoutsource the bulk of their claimsmanagement believe that this givesthem greater flexibility in increasingor decreasing volumes of business,which could provide a considerablecompetitive advantage at thispivotal stage in the underwritingcycle. Given the substantialfinancial sums at stake, the choice of outsourcing partner tendsunsurprisingly to depend onreputation, technical competenceand financial security, with anaverage of some 120 separatedelegated claims authorities beingused in any one organisation.

Most contracts with outsourcersinclude service level agreementscovering such areas as servicestandards, referral limits,remuneration and terminationclauses. However, few include non-performance remedies or tax clauses even though some

‘Outsourcing has

allowed us to grow at

a phenomenal rate

without the aggravation

of premises and

recruitment. If we need

to start reducing the

size of our business it

will make it easier to

scale back.’Survey respondent


57%

29%

14%

IncreaseStay the sameDecreaseNo view

How, over the next 12 months, doyou envisage the level of delegatedclaims handling will change?


Perceived technical competence

Financial security

Reputation

Costs/Cost control

Geographical location/coverage

Pre-existing relationship

Transparency of performance measurement criteria with contract terms

IT/Reporting capabilities


Range of services provided

Please grade the key factors in selecting the third party to which you will delegate claims handling authority



outsourced services could be liable for VAT. The level of auditing varieswidely, with some inspecting allcontractors while others concentrateon a selected few. The primary areasfor scrutiny are adherence to referralcriteria and the correct establishmentof coverage.

Performancemanagement

Performance management is sketchyat best.

Our 2002 survey identified a lack ofperformance measurement in claimsmanagement. Although nearly allparticipants now use some kind ofmanagement information to help runtheir claims function, it is not alwaysupdated every month. The quality ofdata capture is also relatively patchy.The indicators used vary, though mostconsider reserving accuracy, the levelof settlement against initial advice, the level of backlogs and the level of claims leakage as the key tangiblemeasures. The main intangibleperformance indicators focus more on the deployment of effectivenegotiation skills and the application of technical knowledge.

People

Attitudes to claims personnel arechanging, though many remain thepoor relations to underwriters.

Although more than three-quarters of respondents believe that the qualityof their claims personnel is ‘above’ or

‘well above’ their competitors and has improved over the last five years,this appears to be at odds with thehigh level of staff turnover. This stands at 15% on average, compared with a 10% target, while vacancies arerunning at an average of 11%.

‘There is a potential

conflict of interest

between outsourcers

and clients. They are

paid on the number

of hours worked.

We need them to

settle as quickly

as possible.’Survey respondent


33%

45%

22%

Well aboveAboveComparableBelowWell belowNo view

What is your perception of the quality of your claims staff versus that of your competitors?


56%22%

11%

11%

Significant improvementMarginal improvementNo changeMarginal declineSignificant declineNo view

Do you feel that the quality of yourexisting claims staff and of the newclaims staff you have been able to recruithas changed over the last five years?


The gulf between those at theforefront of claims ‘valuemanagement’ and those that lagbehind is perhaps most marked intheir focus on people. Leadingorganisations link the pay of theirclaims operations with performancein specific areas such as level ofleakage and reserving accuracy,along with the personal qualities ofproactivity, technical knowledgeand communication/negotiation

skills. These qualities are nurturedthrough investment in structuredtraining programmes and careerdevelopment planning, which have been adopted by around 50% of respondents.

The aim of this level of investmentin people is to ensure that claimsstaff are ‘first among equals’, with equivalent status and careeropportunities as their underwriting

colleagues. ‘Claims people feel likesecond class citizens. Yet they arepart of the front office. We need to make them feel that they arevalued,’ said one interviewee. In many cases, the shake-up inclaims is coming from a new breedof claims director, some of themhaving been brought in from otherfields such as the legal professionor specialist run-off operations.

‘I think there is

a perception that to

get to the top of the

insurance industry

is tough for

claims people.’Survey respondent


44%

22%

56%

78%

44% 56%

11%

22%

89%

78%

Company/syndicate profitability

Reserving accuracy

Feedback from brokers

Level of claims leakage

None

0 100%

YesNo

Which of the following tangible performance indicators are linked to individual claims handler remuneration?


44%

22%

56%

56% 44%

56% 44%

67% 33%

67% 33%

78%

22% 78%

11%

22%

89%

78%

Innovation

Level of market awareness

Market networking

Support/training for more junior staff

Level of technical knowledge

Proactivity

Communication/negotiation skills

Personal flexibility

None

0 100%

YesNo

Which of the following intangible performance indicators are linked to individual claims handler remuneration?


Financial reporting

Up to speed

Fast close

Reporting standards

Management information

People

CFOs are striving for faster andsmarter reporting. The latestdevelopments such as ‘fast close’offer a glimmer of hope.

Fast close

‘Fast close’ can dramaticallyshorten reporting times.

The overall picture of financialreporting within the LondonInsurance Market, particularly in Lloyd’s, continues to be marked by a high degree of volume andcomplexity, with insurerscontinuing to struggle with

numerous reporting bases to suit a variety of masters.

Not surprisingly, 90% of CFOs inour survey are actively seeking to‘reduce reporting times’. Some havealready achieved their objectiveswith the fastest reporter in our surveyproducing year-end insuranceresults in just 15 days. The averageis 48 days. The maximum is a moreleisurely 75 days.

Press releases are seen as the bestway to publicise the annual andquarterly/half yearly results. The most important stakeholders for this information are consideredto be the shareholders, followed by analysts, regulators, employees,tax authorities and reinsurers.

A significant development since our survey last year has been theattention insurers have directed to ‘fast close’ procedures aimed atrationalising a complex and lengthyreporting process, which for someorganisations incorporates a veryhigh number of sets of auditedaccounts, some of which are not

‘Let’s streamline

the reporting process

and let’s understand

what we want to get

out of it.’Survey respondent


90% 10%

70%

50%

30%

50%

10% 90%

10% 90%

Reducing reporting times (i.e. fast close)

Reducing the number of reporting entities

Hiring additional finance staff

Reducing the number of finance staff

Outsourcing more activities

0 100%

YesNo

Which, if any, of the following activities are you actively considering in respect of your financial reporting function?


Financial reporting continued

completed until up to ten months after the year-end. ‘Fast close’ allowsfinance teams to streamline theirreporting processes through thecapture, warehousing andinterrogation of core underwriting,claims and general ledger data tomaximise automation of accountpreparation under a range of differentreporting bases.

Insurers need to deploy systemscapable of maximising the automationof reporting routines. However,maximising its potential is far morethan a systems issue. In particular,organisations need to be able tocapture sufficient and appropriatedata, which requires understandingand buy-in from all sectors of the business, including claims and underwriting.

Reporting standards

The volume and complexity ofreporting could get worse before it gets better.

Although Lloyd’s has taken steps torationalise its reporting, many ofLondon’s insurers are still struggling to cope. Our survey found that theaverage number of audited sets ofaccounts/financial returns is 28 peryear. The average proportion of financeteam time spent producing externalinformation is 34%, though it can take up to 75%.

The burden of multiple reportingbases, be they UK GAAP, US GAAP,Lloyd’s and UK regulatory, is often

exacerbated by complex groupstructures that require organisations to provide vast amounts of informationto both their own and their parentcompany management. It is thereforefar from surprising that 58% of CFOsin our survey are looking to reduce the number of reporting entities.

Although the coming move toInternational Financial ReportingStandards is designed to harmoniseaccounting across the EU, the scaleand complexity of the phased changesare likely to make reporting get worsebefore it gets better. Around 80% ofour respondents anticipate that theywill need to adopt IFRS in theirprimary statements in 2005, yet lessthan half have drawn up a formal IFRS implementation plan.

Management information

Management information is often too slow to meet the demands of a fast moving market.

Overall, respondents appear to beonly marginally satisfied with theirmanagement information, with theproduction process, timeliness andoverall form and content scoringlowest overall. The main sources of delay in MI production are seen as poor systems and the lack ofavailability of premium andreinsurance recovery estimates.Underlying these difficulties are the lack of compatibility andcomparability between internalunderwriting year data and theaccident year reporting typically

‘I think the key

stakeholders in our

business don’t

understand Lloyd’s

reporting and why

should they? That’s

why Lloyd’s are

looking to change

their accounting

process to bring it

into line with what

people understand.’Survey respondent


employed by insurers in the sector, as well as the need to provide highlevel information on a UK/USGAAP basis.

Our survey shows that MI is stillheavily focused on profit and lossmeasures, cash flow analysis, largeclaims losses and premium andreinsurance receivable collections.There is less focus on balance sheetanalysis and regulatory solvencyissues. Information packs alsogenerally lack data on emerging

claims trends, operational risk andthe kind of stress and scenariotesting that is likely to be requiredunder the PSB. The FSA has alreadybrought its weight to bear in theArrow visits that have led to atightening of processes anddocumentation in claims. Regulatorypressure is set to mount with theadvent of the new solvency and riskmanagement framework set out inthe PSB. However, while more than80% of respondents believe theywill be affected by the new rules,

‘We benchmark our

KPIs against plan.

If they’re on track

we leave it at that

and focus on the

exception items.’Survey respondent


Selection and analysis of key performance indicators

Quality and clarity of financial information

Frequency of production

Quality of the underlying data

Ability to use the MI to make key decisions

Quality of the discussion/feedback from Board members

Overall form and content

Timeliness of production

Not satisfied Fully satisfied

Process of producing the information

In terms of management information (presented at Board level) please grade how satisfied you are with the following


Availability of premium estimates

Availability of actuarial estimates

Quality of systems

Availability of reinsurance recovery estimates

Quality of data/reconciliation

Quality of IT staff

Quality of finance staff

Information from Lloyd’s/bureaux

Information from outsourcing companies

Information from parent company

Not a barrier Very significant barrier

Information from other subsidiaries

Please grade the following factors that prevent you from producing your management information more quickly


Financial reporting continued

only 42% have drawn up a projectplan for the systems and controlsrequirements and only 17% forenhanced capital requirements.

People

Finding the right people remains a problem.

Attracting finance staff with therelevant market experience continues to be a problem. Some 40% ofrespondents are looking to hireadditional people in the financefunction – mostly in the area ofexternal financial reporting, but also in regulatory, compliance and management reporting. IFRS andnew regulations are likely to heightenthe pressure on finance staff.



Background

What is the London Insurance Market?

A subscription market in which various entities participate:

• 71 Lloyd’s syndicates (backed either by individual Names or corporate capital) in 2003;

• UK-domiciled insurers and reinsurers; and

• UK subsidiaries and branches of US, European and international insurers and reinsurers.

Total capacity of around £25 billion in 2003:

• £14 billion capacity within Lloyd’s alone.

Reputation as long-established market:

• Large proportion of major global organisations have policiesplaced within the London Market; and

• Over 96% of FTSE 100 organisations and over 93% of the Dow Jones Index constituents have policies placed within the London Market.

Quality of underwriting expertise, particularly in speciality risks:

• The London Market share of the world’s aviation market is over 29%; and

• The London Market also has substantial global market share in marine and energy risks.


Contacts

If you would like to discuss any of the issues raised in this survey in moredetail please speak to your usual PricewaterhouseCoopers contact, or oneof the partners listed below:

Philip CalnanPartnerPhone: 44 20 7212 4419Email: [email protected]

Paul DelbridgePartnerPhone: 44 20 7212 3085Email: [email protected]

Andrew KailPartnerPhone: 44 20 7212 5193Email: [email protected]

Survey Participants

We would like to take this opportunity to thank all those organisations andexecutives who agreed to participate in the development of this survey.We are extremely grateful for the time that they gave us and especially forthe openness with which they discussed the key issues facing their industry.

Production

The development and production of this survey involved a significantnumber of people and we would like to thank those listed for theirvaluable contribution.

John Ashworth

Vincent Branch

Sarah Redgers

Paul Mahon

Buu Truong

Mark Knowlson

Melinda Strudwick

Donald Brignell

Gauri Haria

Carrie O’Neill

Áine O’Connor

Alpa Patel


PricewaterhouseCoopers (www.pwc.com) is the world’s largest professional services organisation. Drawing on the knowledge and skills of more than 150,000 people in150 countries, we help our clients solve complex business problems and measurably enhance their ability to build value, manage risk and improve performance in an

Internet-enabled world.

PricewaterhouseCoopers refers to the member firms of the worldwide PricewaterhouseCoopers organisation.If you would like additional copies of this survey please contact Áine O’Connor, Head of Financial Services Marketing, on email [email protected]

Copyright © 2003 PricewaterhouseCoopers. All rights reserved. Designed and produced by studio ec4 (15418 08/03).

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