A significant insurer, having successfully capitalised on the upswing of the underwriting cycle after 9/11, has positioned itself to navigate successfully the inevitable downswing. In particular it has:

- developed a basis for identifying the point at which underwriters should walk away from business offered to them so as to ensure that the company achieves its target for long-term return on capital; - provided underwriters with an understanding of the total system of financial dynamics, rather then just the loss ratio on which they previously focused; - identified a better way to interpret loss ratios , to help underwriters identify the walkaway point.

The Issue

Following 9/11, premium rates for most business increased substantially. Like many Insurers, the company did very well out of this. Between 2003 and 2004, its profit before tax rose by a substantial margin.

The Insurer’s CEO and its Chief Actuary were well aware that that this level of profitability was not sustainable. The cycle would inevitably turn and premium rates begin to drop again. To maximise profits across the cycle, underwriters needed to know when to decline risks on the basis of inadequate pricing to ensure that the business met its targets on long term return on capital.

The company had already done some work in this area, to make underwriters aware, when they wrote business, what ultimate loss ratio would be needed to get an adequate return. They had also carefully tracked pricing strength and projected expected price movements into the coming years. In a hard market, underwriters could often target lower loss ratios but, as conditions changed, the challenge was to determine at what point to let the business go – never an easy decision.

The Analysis

A conversation with Stewart Coutts and John Murray of TGP Management Advisers suggested to the CEO and the Chief Actuary that a better approach might be possible. The TGP consultants talked about the ‘walkaway’ price point below which business written destroys value, and how this theoretical concept could be operationalised.

‘Business lost may always be regained, but money lost is gone forever’ said TGP’s John Murray.

The TGP approach involved ensuring that the results achieved across the duration of the underwriting cycle were at or above the required long term return on capital.

The project was focused on a single class of business, with a view both to making the project manageable and to developing techniques that could be adapted to other lines later.

The business itself was rated either by the use of independently produced statistical data or by the use of customer-generated information, where the customer was of sufficient size for its own database to be credible. In certain cases a hybrid methodology was utilised, the underwriters using independent data to overlay customer-produced statistics.

This approach was applied equally to business directly underwritten, reinsurance inwards and business transacted by way of binding authorities or similar arrangements.

As a first step, the TGP consultants worked with the client to understand the rate of return contribution required for the class of business by reference to selected capital density, the planning methodology employed, the historic business performance, the allocated and direct costs relating to the line, the reinsurance dynamics, any line of business interdependency and the pricing methodology adopted by the Underwriter.

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