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Managing the cycle: insurance carriers that fail to maintain underwriting discipline throughout the market cycle risk putting short-term gains ahead of long-term profit.

While not as predictable as the phases of the moon, the insurance market cycle is a fairly reliable trend. A hard market is followed by a period of generally flat rates, which precedes a soft market, then another period of flat rates and--coming full circle--another hard market. The cause, duration and depth of each period may vary, but the cycle does not.

Insurers, however, need not let their business decisions be completely dictated by the fluctuating market. If they do, it will compel them to put short-term results before long-term financial health. To lessen the impact, carriers need to maintain underwriting discipline in the face of pressures to slash premiums, offer broader terms and increase market share.

Commercial insurance prices have leveled off after years of hard-market growth. It is during the current period of flat renewal rates that commercial customers may look to switch insurance carriers to gain more favorable pricing. In response, insurers may be tempted to renew policies for less premium to retain their business, or they may undercut other carriers' prices to gain market share and immediate short-term profits.

But gaining market share in a soft market by dropping prices is a gamble. It can boost an insurance carrier's top and bottom line in the short term, but over time, the result is inevitable--poorer margins and greater exposure. In the battle for market share, insurers often find that all they've gained is a growing book of underpriced risk.

This strategy of booking more business at lower rates ignores the reality of general price inflation. Costs for building materials, equipment, services, labor, health care, legal fees and just about everything else are constantly on the rise. If insurers are collecting fewer premium dollars from businesses to help protect against property and liability exposures, profitability eventually will suffer.

An insurer that gains market share by undercutting competitors' prices may experience a strong year or two because of the additional premium. But the insurance industry should not be in the business of turning around a quick profit by catering to the latest market demands. Insurance contracts, while often renewed on an annual basis, are long-term commitments. The premiums that insurers collect this year will help to pay for claims years in the future.

That is why insurers that are increasing their market share in the soft market should pay close attention to reserves. When rates are on the decline, insurers' profit margins narrow. At the same time, the growth in new business at lower rates increases the chances that a carrier will have to pay more claims in the future.

Problems also can arise when insurance carriers establish growth targets that are out of synch with the underwriting strategy. The message from the top should always be: "Maintain underwriting discipline."

Even when that message is being preached by the top management, there's no guarantee that it is being practiced in the field. That's why it's important to know what the field underwriters are doing come renewal time. For example, let's say an underwriter in a branch office reduces premiums for a $1 million account by 10% in an effort to keep the business. That one rate reduction may have little impact on an insurance carrier's bottom line, but if field underwriters in other branches are doing the same thing for their biggest accounts, the impact could be tremendous.

Disciplined underwriting involves making tough choices. Insurers must be prepared to explain to their customers why rates are rising. If necessary, they should walk customers through the underwriting process to show them bow they made their decision. They should be able to advise customers on ways to reduce exposures, and, therefore, decrease the potential for claims or decrease the severity of claims. Finally, they must be willing to walk away from business if it doesn't make sense from an underwriting standpoint.

Insurance carriers have a choice: they can ride the waves of the market cycle bobbing up and down like a small boat on the open sea, or they can chart their own course to long-term profitability on an ocean liner called disciplined underwriting.

Steven R. Pozzi, a Best's Review contributor, is senior vice president, Chubb & Son, and chief underwriting officer for Chubb Commercial Insurance. He can be reached at
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Title Annotation:Property/Casualty: Underwriting Insight
Author:Pozzi, Steven R.
Publication:Best's Review
Geographic Code:1USA
Date:Oct 1, 2006
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