Waking up from an underwriting disaster

In recent times much has been written about underwriting and pricing discipline, though less on how to achieve it. The market seems to be like a variation on the proverbial curate's egg right now - soft in parts.

The temptation for underwriters on individual cases are of course many and seductive. The necessity of pricing for large claims funding can be overlooked, a generous view of claims trends can be taken and pricing for claims inflation or expenses can be diluted.

Often the consequences of such actions aren't visible on individual cases and only appear in the overall results a number of months or even years later.

I am certainly seeing pockets of irresponsible underwriting with cases being underfunded by up to 40% in extreme cases.

This kind of ill-disciplined pricing is particularly alarming, especially for injury-led classes of business such as employers' liability. Changes to the discount rate, a collapse in investment returns, increased awards for pain and suffering and the explosion in conditional fee arrangements were some of the key drivers for rate increases in this line of business.

Irresponsible underwritin
Yet despite the fact it is only two years since these painful pricing corrections were made, irresponsible underwriting is still an issue for the insurance industry. I am beginning to wonder whether long-term memory failure is a new industrial disease affecting underwriters in this sector.

Employers' liability has caused massive losses in the past for the industry and many of the claims drivers remain in place.

The potential for long-tail disease claims remains significant and has to be priced for. Changes in medical knowledge, case law or legislation can all have a major impact and emerge almost daily.

An example of this are the noise regulations scheduled for 2006 that will lower the threshold at which employers have to take action to prevent hearing loss. To what extent this will result in future claims is of course harder to evaluate but it cannot simply be ignored.

Most commentators agree that injury claims inflation is still well above retail price inflation and is estimated at between 6% and 12% depending on the type of injury. There are known forthcoming claims costs to be funded for, such as NHS recovery charges, and the legal environment also remains uncertain. Debates about the correct level of the discount rate continue and any change could have a huge impact on numbers.

Finally, the low investment environment and the need for shareholders and other investors to receive a consistent and adequate return are both well publicised and well known. So why does it seem the industry is in danger of sleepwalking to disaster?

Necessary component
One reason could be the number of components necessary to truly instil pricing discipline within an organisation.

First-class pricing tools supplemented by strong and reliable management information is the first essential ingredient. This helps provide a sound basis for accurate pricing and ensures that all the appropriate pricing components are fully costed in.

Sophisticated pricing recording systems are also essential. These should enable underwriters and managers to capture in real time the level of pricing being achieved on each case and see how each underwriter, team or branch is performing against the overall pricing requirements.

A clear and ongoing understanding by all staff of the cost drivers that go into making up the price of a risk is vital.

Equally important is the understanding of how variations in price can quickly dilute the overall profitability of an organisation, leading through to a direct impact on shareholder value. The power of leaders, sales teams and underwriting staff talking the same language and sharing common insights cannot be underestimated.

There needs to be a clear end-to-end execution culture with all staff understanding the required pricing strategy and how to implement it. A clear linkage to performance management and appraisals is vital.

Strong governanc
Finally, a strong governance process is a pre-requisite. This will enable a clear understanding of the extent of any pricing leakage and the reasons why it occurs. This process can then act as a driver for change to eliminate leakage either by further refinement of pricing tools or training of underwriters in the field. This should take place on a regular basis to gain full impact.

These are the key factors necessary to sustain pricing and underwriting discipline. And while it is unrealistic to believe we can eliminate the insurance cycle completely, a smoother cycle has benefits for everyone.

Customers want stable and predictable prices and the knowledge that insurers will be there to pay claims. Shareholders and other capital providers demand a worthwhile return from their investment and know that poor pricing is a major threat to this aspiration.

Brokers and insurers would, I believe, also welcome the chance to talk more about the wider insurance proposition and how they can help customers, rather than focusing solely on the pricing merry-go-round.

To be truly successful, pricing discipline has to be embedded into the core values of the organisation. This is not as easy to do as it may sound and can take two to three years of sustained effort to get there.

Leading edge organisations will now move on to find further ways to improve their approach to pricing - by this they can guarantee staying a step ahead of the competition. IT

' Graham Prior is underwriting director for Zurich's UK commercial business