True value: few insurers meet the challenge of making a profit through underwriting prowess and investment returns--but the ones who do, share interesting characteristics. (Property/Casualty: Profitability).Creating value for the owners of insurance companies--whether shareholders or policyholders--should be the key objective for insurance executives. Achieving and sustaining this value aspiration aspiration /as·pi·ra·tion/ (as?pi-ra´shun) 1. the drawing of a foreign substance, such as the gastric contents, into the respiratory tract during inhalation. 2. , however, has proven to be an elusive goal. Over the past 15 years, property/casualty insurers have faced a number of challenges, including a prolonged pro·long tr.v. pro·longed, pro·long·ing, pro·longs 1. To lengthen in duration; protract. 2. To lengthen in extent. soft market, natural and manmade catastrophes and volatile investment returns. It was against this backdrop Backdrop may refer to:
The study examined the 75 largest U.S. property/casualty writers as measured by net premiums written in 2001. These 75 carriers consisted of personal and commercial insurers represented all ownership types--mutual, reciprocal Bilateral; two-sided; mutual; interchanged. Reciprocal obligations are duties owed by one individual to another and vice versa. A reciprocal contract is one in which the parties enter into mutual agreements. , private and publicly traded--and collectively made up more than 80% of the property/casualty industry's premium. The study's scope included a comprehensive analysis spanning 1987 to 2001 and focused on identifying the sustainable-value creators and determining their winning strategies and tactics. Study Approach The value measurement approach centered on cash flow generated compared to the minimum return required for each insurer An individual or company who, through a contractual agreement, undertakes to compensate specified losses, liability, or damages incurred by another individual. An insurer is frequently an insurance company and is also known as an underwriter. on an annual basis, over the 15-year time period. The primary tenet TENET. Which he holds. There are two ways of stating the tenure in an action of waste. The averment is either in the tenet and the tenuit; it has a reference to the time of the waste done, and not to the time of bringing the action. 2. was that in order to create value, insurers need to generate cash flow in excess of their annual cost of capital. Simply put, insurers generating cash flow exceeding the annual cost of capital create value, while those who do not, destroy value. The annual cash flow requirement was determined by two key factors: interest-bearing assets that insurers held for a given year and annualized annualized Of or relating to a variable that has been mathematically converted to a yearly rate. Inflation and interest rates are generally annualized since it is on this basis that these two variables are ordinarily stated and compared. cost of capital charged against the assets. The minimum rate of expected return Expected Return The average of a probability distribution of possible returns, calculated by using the following formula: used for all insurers in the study was based on the average return of the S&P 500 over the past 20 years. The key source of data was the annual, statutory financial statements of the 75 insurers, and the analysis employed a consistent process: Determined invested capital base. Adjusted the balance sheet in order to identify operational assets less non-interest bearing liabilities and unrealized gains Unrealized Gain A profit that results from holding on to an asset rather than cashing it in and using the funds. Notes: Let's say you own a stock that has doubled, but you haven't sold it yet. This is said to be an unrealized gain. and losses. Assigned as·sign tr.v. as·signed, as·sign·ing, as·signs 1. To set apart for a particular purpose; designate: assigned a day for the inspection. 2. cost-of-capital charge. Used a cost-of-capital rate based on the 20-year average of the S&P 500, regardless of actual cost of capital, capital structure or return volatility. Calculated required return. Determined annual cash flow requirement by multiplying mul·ti·ply 1 v. mul·ti·plied, mul·ti·ply·ing, mul·ti·plies v.tr. 1. To increase the amount, number, or degree of. 2. Mathematics To perform multiplication on. interest-bearing capital base for given year against the long-term Long-term Three or more years. In the context of accounting, more than 1 year. long-term 1. Of or relating to a gain or loss in the value of a security that has been held over a specific length of time. Compare short-term. S&P 500 return. Assessed value creation. Calculated the difference between actual cash flow generated and the required return in order to determine whether the insurer created or destroyed value on both an annual and cumulative basis. Insurers whose cash flow returns did not exceed the minimum requirement were deemed value destroyers, while those with cash flows larger than their capital requirement were designated value creators. Value creators were further examined to identify those insurers generating positive cumulative cash flows from underwriting Underwriting 1. The process by which investment bankers raise investment capital from investors on behalf of corporations and governments that are issuing securities (both equity and debt). 2. The process of issuing insurance policies. as well as investment results. Value creators that had negative underwriting cash flow but positive cumulative returns from investments were considered hollow-value creators. Value creators with positive cumulative cash flow results from both underwriting and investments were considered sustainable-value creators. These carriers are best positioned to continue to create value regardless of capital market performance and to generate cash flow from underwriting. Key Findings While the scope of the analysis included both personal and commercial lines, the synthesis and implications focused on personal-lines insurers. Over the period studied, commercial-lines carriers suffered from a prolonged soft market and large catastrophe Catastrophe, from the Greek Καταστροφή (katastrephein), literally means "to turn" (strephein) "downwards" (kata-). exposures, which posed unique commercial-lines challenges. Interestingly, only niche, specialty commercial-lines carriers were identified in the study as sustainable-value creators. Given their unique business approaches and markets, these commercial carriers are excluded from the remainder of the discussion, due to a lack of broad implications for the industry. The personal-lines segment of the analysis identified 24 value-creating insurers--carriers generating cash flow exceeding the minimum required return. Collectively, these insurers created more than $41 billion in value for their owners from 1987 to 2001. Thirteen insurers were identified as hollow-value creators and solely relied on investment cash flow. These carriers were predominantly pre·dom·i·nant adj. 1. Having greatest ascendancy, importance, influence, authority, or force. See Synonyms at dominant. 2. publicly traded companies publicly traded company A company whose shares of common stock are held by the public and are available for purchase by investors. The shares of publicly traded firms are bought and sold on the organized exchanges or in the over-the-counter market. , distributed through independent agents and provided a diversified diversified (di·verˑ·s product mix, including financial services The examples and perspective in this article or section may not represent a worldwide view of the subject. Please [ improve this article] or discuss the issue on the talk page. and life insurance. The remaining 11 insurers created sustainable value Sustainable Value Sustainable Value is an approach to measure and manage sustainability performance. The concept was developed by researchers who are working today for Queen's University Belfast from both underwriting and investment cash flow. (See "Sustainable-Value Creator Business Lines.") The validity of the value-creator approach was reinforced by the fact that sustainable-value creators were more than seven points better than the study population when comparing their combined ratio less policyholder Policyholder An individual who owns an insurance policy. dividend vs. the total study population. Moreover, their total underwriting expense ratio was 28% better than the study average, and they were able to perform nearly four points better on their average loss-incurred ratio than the industry. (See "Average Selected Operating Ratios Operating Ratio A ratio that shows the efficiency of management by comparing operating expense to net sales: for Personal Lines Insurers, 1987-2001," page 58.) Selected Insights Comparing sustainable-value creators with other value groupings reveals several striking qualitative and quantitative insights. At first glance, the sustainable-value creators appear extremely diverse; however, upon closer examination, several common characteristics emerge. Four key areas of consistency among the sustainable-value creators are * underwriting, * channel, * product, and * customer. Underwriting From 1987 to 2001, the property/casualty market experienced soft rates and exceedingly ex·ceed·ing·ly adv. To an advanced or unusual degree; extremely. exceedingly Adverb very; extremely Adv. 1. high investment returns, allowing many insurers to become lax LAX - LAnguage eXample. A toy language used to illustrate compiler design. ["Compiler Construction", W.M. Waite et al, Springer 1984]. in underwriting. Sustainable-value creators maintained focus on underwriting, however, and chose not to grow at the expense of underwriting profit Underwriting profit is a term used in the insurance industry. It consists of the earned premium remaining after losses have been paid and administrative expenses have been deducted. It does not include any investment income earned on held premiums. . These insurers followed a disciplined underwriting approach and selective risk selection. For example, Mercury General used its pricing expertise, risk classification and understanding of the California California (kăl'ĭfôr`nyə), most populous state in the United States, located in the Far West; bordered by Oregon (N), Nevada and, across the Colorado River, Arizona (E), Mexico (S), and the Pacific Ocean (W). market to achieve an average combined ratio that was 15% better than the industry's over the past decade. Horace Mann leveraged its insight in the educator market and implemented tiered auto pricing, expanded its underwriting guidelines guidelines, n.pl a set of standards, criteria, or specifications to be used or followed in the performance of certain tasks. , improved profitability and applied more restrictive underwriting in 25 states. This committment to underwriting was also reflected in management's willingness to spend aggressively on customer acquisition. Sustainable-value creators spent nearly 30% more than hollow-value creators and nearly 15% more than the study average on policyholder acquisition. AAA AAA: see American Automobile Association. (Triple A) A common single-cell battery used in a myriad of electronic devices of all variety. Like its double A (AA) cousin, it provides 1.5 volts of DC power. When used in series, the voltage is multiplied. of Southern California Southern California, also colloquially known as SoCal, is the southern portion of the U.S. state of California. Centered on the cities of Los Angeles and San Diego, Southern California is home to nearly 24 million people and is the nation's second most populated region, had the highest average acquisition expense ratio of the sustainable-value creators while maintaining an average combined ratio of 96 less dividends. Given the company's affinity-group distribution approach, it was able to keep commission expense at a minimum and used the savings to penetrate its market and focus on underwriting. Channel Analysis of sustainable-value creators revealed that the majority distribute directly and consequently had the lowest average commission ratio--nearly six points less than the study average. Considering commission and other acquisition costs in aggregate, sustainable-value creators were still spending significantly less than the other carriers. Geico, for example, is able to achieve significant growth with underwriting profitability using the direct model with steadily improving retention and customer-service levels. Progressive is extremely successful in managing potential channel conflict as evidenced by its strong premium growth and steadily improving combined ratio. Traditional agency-based distributors cannot ignore the momentum toward self-directed sales and service. While a significant portion of the U.S. population will continue to prefer the agency channel, there is an increasing unwillingness to pay for the associated costs of this model. This analysis of value creation would indicate that carriers historically have been unable to receive appropriate pricing differentials for bricks-and mortar sales and service. Product Given the poor results in the homeowners' line of business, it was not surprising that the majority of premium written by sustainable-value creators was auto. In general, sustainable-value creators avoided the challenging homeowners market. On average, however, 5% of their net premiums written came from the homeowners line of business, and given the firming rates, this percentage may increase. When homeowners was offered by sustainable-value creators, it was part of maximizing customer lifetime value and held to appropriate levels of underwriting profit. Sustainable-value creators kept their average homeowners combined ratio over the 15-year time period to approximately 106. If the policyholder dividends are excluded from the combined ratio calculation, the average becomes 99.8-they made underwriting profit. The sustainable-value creators were also more likely to offer commercial policies. They tended to focus on small commercial auto, however, in keeping with their core underwriting and claims capabilities. Customer A common theme across all sustainable-value creators was a relentless focus around the development and delivery of tailored, unique customer-value propositions. For example, USAA USAA United Services Automobile Association USAA Urban Superintendents Association of America USAA United States Achievement Academy USAA United States Arbitration Act of 1925 USAA United States Axemen's Association USAA United States Air-Table-Hockey Association caters to military personnel and has developed unique sales and service options to match its customers lifestyles. Other examples of focusing on discrete customer demographics The attributes of people in a particular geographic area. Used for marketing purposes, population, ethnic origins, religion, spoken language, income and age range are examples of demographic data. include GE Financial, which uses a tailored business model to target mature drivers over the age of 40. Some sustainable-value creators aggressively developed affinity-group alliances to secure preferred groups of customers. Alliances with auto clubs have proven to be very successful for a number of sustainable-value creators, given that membership normally indicates a risk-averse Risk-averse Describes an investor who, when faced with two investments with the same expected return but different risks, prefers the one with the lower risk. segment with a higher willingness to pay Willingness to pay (WTP) generally refers to the value of a good to a person as what they are willing to pay, sacrifice or exchange for it. See also
Many sustainable-value creators have focused on target customers based on specific geographic regions. For example, Commerce and New Jersey Manufacturers all write the majority of their business in one dominant state. It is interesting to note that these insurers write in some of the most challenging states from a regulatory standpoint The Standpoint is a newspaper published in the British Virgin Islands. It was originally published under the name Pennysaver, largely as a shopping-coupon promotional newspaper, but since emerged as one of the most influential sources of journalism in the . While many national insurers avoid Massachusetts and New Jersey, Commerce and New Jersey Manufacturers have built their entire infrastructures and business processes around the uniquenesses of the regulatory environments in a profitable manner. Clearly, no single set of strategies or tactics led to sustained-value creation over time. While there are common traits shared by the sustainable-value creators, each has unique strategies--whether to focus on a specific distribution approach or geography, provide a select product mix or target a unique customer segment. Common value-creation imperatives identified include the following: Underwriting: Do not focus on investment returns, but rather invest in underwriting capabilities. Channel: Ensure that the economics of a chosen channel strategy are reflected across the business strategy and tactics. Product: Ensure adequate underwriting profitability across all lines and aggressively manage accommodation products to ensure maximization of customer lifetime value. Customer: Develop unique and tailored customer-management strategies based on the customer's willingness to pay, customer preferences and risk exposure.
Sustainable-Value Creators
These insurers create positive cash-flow results from both underwriting
and investments.
($ Billions)
Cumulative Underwriting Investment
Value Created Value Created Value Created
USAA $5.2 $ 1.4 $ 3.8
MA of Southern California 3.3 2.1 1.2
New Jersey Manufacturers 1.9 0.5 1.4
California State Auto 1.5 0.3 1.2
Amica Mutual 1.1 0.4 0.7
GE Financial 1.0 0.0 1.0
Geico 0.8 0.2 0.6
Progressive 0.6 0.2 0.4
Commerce 0.5 0.1 0.4
Mercury General 0.4 0.1 0.3
Horace Mann 0.3 0.0 0.3
Source: IBM
Average Selected Operating Ratios
For Personal Lines Insurers, 1987- 2001
The validity of the value-creator approach was reinforced by comparing
combined ratios.
Sustainable- Hollow-
Value Creators Value Creators
Combined Ratio 102.7 104.4
Combined Ratio Less 96.5 104.4
Policyholder Dividends
Loss Ratio 63.5 67.5
Loss Adjustment Expense Ratio 13.2 10.0
Total Expense Ratio 19.9 27.0
Commission Ratio 5.0 13.0
Policyholder Acquisition Ratio 7.3 5.3
General Ratio (General 4.6 5.9
Business Expenses)
Value Total
Destoryers Study
Combined Ratio 106.2 104.9
Combined Ratio Less 106.0 103.7
Policyholder Dividends
Loss Ratio 68.5 67.2
Loss Adjustment Expense Ratio 11.1 11.1
Total Expense Ratio 26.4 25.4
Commission Ratio 11.3 10.7
Policyholder Acquisition Ratio 6.6 6.3
General Ratio (General 5.9 5.7
Business Expenses)
Source: IBM
RELATED ARTICLE: Defining Value * Value Creators--companies with cash flows larger than the capital requirement * Sustainable-Value Creators--companies that generate positive cumulative cash flows from both underwriting and investments * Hollow-Value Creators--companies that exceed capital requirements Capital requirements Financing required for the operation of a business, composed of long-term and working capital plus fixed assets. but have positive cumulative returns only from investments and negative returns from underwriting * Value Destroyers--companies with cash flow returns that don't exceed the minimum return on capital Sustainable-Value Creator Business Lines Most of the premiums written by sustainable-value creators are auto. * Amica Mutual--multiline insurer * AAA of Southern California--multiline insurer * California State Automobile Association--multiline insurer * Commerce Group Inc.--auto, homeowners and commercial auto insurer * GE Financial--multiline insurer * Geico--personal lines insurer * Horace Mann Insurance Group--multiline insurer * Mercury General Group--commercial and private passenger auto insurance and homeowners insurance * New Jersey Manufacturers Group--commercial and private passenger auto insurance and homeowners insurance, workers' compensation workers' compensation, payment by employers for some part of the cost of injuries, or in some cases of occupational diseases, received by employees in the course of their work. insurance * Progressive Corp.--private-passenger auto and commercial auto insurance * USAA Group--multiline insurer Sustainable-Value Creator Quick Facts * Out of the 75 property/casualty companies in the IBM study, 11 personal lines insurers generated sustainable value through both underwriting and investment results. * The companies register combined ratios less policyholder dividends almost seven points better than the total study population. * Most of the premiums written are auto. * The majority distribute directly. * Many have a geographic focus. William N. Pieroni is general manager of IBM Global Insurance Industry, White Plains, NY |
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