A fresh take on the short-term underwriting cycle

Insurers say that their profitability is under threat due to natural disasters such as the October 2012 Gauteng hailstorms, significant increases in both the volume and quantum of claims and an under-priced market premium structure, among other factors. Will higher premiums be the cure-all the insurers hope for?

 

What we should be asking is: how did the industry reach this point? Why did it take so long for insurers to sound the alarm? And whether a knee-jerk rate hike is the most sensible solution given that underwriting capacity remains high? Another important consideration is whether the broader insurance market will react to premium increases in the same way it has done in the past.

Those of us who have been around the block a few times will clearly remember the phenomenon called the soft underwriting cycle. After talking to a younger friend and colleague some weeks back, one who often finds himself under pressure from shareholders, I was taken aback to learn that he had no first-hand experience of the down side of the trend.

I had to reassure him that it was not the end of the world, that many of us had experienced a number of down cycles in our lifetimes and that there was light at the end of the cycle. Although the hard times are difficult to explain to shareholders who are only interested in growth, profit and return on investment, the industry will recover.

A typical underwriting cycle spans a number of years. At the start of the cycle, insurance capacity is plentiful and insurers post record profits. Rates begin to fall (and margins take strain) when competitors in this healthy market battle each other for market share.

The turn in the cycle comes when a series of natural disasters occur in quick succession resulting in a surge in the number of claims. In South Africa the market has been further impacted by a dip in the economy which goes hand in hand with rising unemployment, a downturn in investment returns and an increase in crime-related and fraudulent claims.

Insurers realise that the market cycle has turned when the surge in claims reflects on their bottom line. Across the market capacity constraints emerge. Rates start to increase and prudent underwriting as opposed to cash flow underwriting measures are implemented.

 

The shift between an up and down underwriting cycle hinges on the overriding economic conditions as well as each industry participant’s willingness to react to them.

As the latest soft cycle unfolds domestically, some insurers are calling for premiums to increase and for a return to proper and more diligent risk assessment practices.

Although their call makes sense, there is too much spare underwriting capacity at present to prevent entrepreneurs (or opportunists if you prefer) from chasing market share by undercutting sensible premiums. In the current environment the insurer might apply a differential rating structure for new and existing business, with the existing client bearing the brunt of higher premiums.

I believe that insurers and risk advisors have similar core focuses of retention, new business, growth and profitability. Any conflicts that arise out of long term sustainability versus short term shareholder demands for profit should therefore be addressed with these factors in mind.

 

Does the risk advisor have a part to play in the on-going sustainability of the market? Of course they do. Your challenge is to apply the principles of professionalism and sound advice and to shield your clients from the rising tide of premium increases by employing sound risk management concepts and innovative solutions. You can leave the profitability debate to the insurers.