Chapter 3

MAIN INFLUENCES ON UNDERWRITING

CORPORATE STRATEGY & UNDERWRITING

STRATEGY

Corporate strategy – is designed to operate firm successfully.

Corporate objectives are high level statements of intent and are usually

expressed in very broad simple terms e.g. to be market leader in a particular

sector within 5 years.

Corporate strategy may include an objective to transact business in a particular

territory, to seek growth or consolidation and profit.

These objectives are influenced by market conditions and opportunities and the

availability of capital and corporate appetite, and will be regularly reviewed, and

adjusted, as necessary.

CORPORATE STRATEGY & UNDERWRITING

STRATEGY

Underwriting strategy - Derived from corporate strategy.

High level objectives is distilled into the underwriting strategy through business

plans, broken down into key elements, including:

• Claim ratio (Premium income to Claims) and expense ratio (Premium

income to Administrative expenses)

• Premium targets and Expected investment returns.

Strategy should be understood and implemented throughout the organization

along with other factors outside the organization for success.

CORPORATE STRATEGY & UNDERWRITING

STRATEGY

Different types of underwriting strategy

Main classes of business:

Insurer can apply its philosophy of a particular class of business to all classese.g. use of direct marketing channels for personal lines also used for otherclasses and this can impact on expense ratio, staff requirement and retentionstrategy.

An insurer can use indirect channels e.g. intermediary for marketing a productdue to its repute or relationship with customers in the market.

Organization offer preferential insurance terms to its members.

Commercial property Liability

Motor Marine and Aviation

CORPORATE STRATEGY & UNDERWRITING

STRATEGY

Different types of underwriting strategy (Cont.)

Personal lines products are often standardised with computer driven technology, while

using sophisticated rating and pricing models to try to secure and retain business in an

intensively competitive market. Underwriting expenses to some extent minimise the high

acquisition costs generated by extensive and expensive media advertising.

Non-standard personal lines, together with commercial lines business, generates

higher average premium but requires more customised underwriting and sometime use

higher commission rate which pressurised the expenses.

Each market or segment has its own attractions.

Product based underwriting strategy – Underwriting, claims, sales, and marketing

division report to a central business management function.

Functional division will operate across products but, ultimately, responsibility for the

underwriting results will rest with a team of senior managers who can be said to operate

the strategic policy.

COMPETITION FOR CAPITAL

Option available to a financial organization with surplus capital:

Gains, losses, and if borrowed capital is involved then interest payable to the

lender & dividend payment to shareholders must be considered for expected

return on capital. Therefore, underwriting function require capital and so

influence the underwriting strategy.

• Insurance co. short time liability – Early claim settlement – Require capital

• Insurance co. long term liability – Claim settlement take time e.g. EL

Purchase a new insurance company or expand its business

Invest in acquiring or building new premises & sold to meet liabilities at short notice

Return capital to shareholders, or do nothing

MARKET SHARE AND PROFIT

Organization’s strategy is derived from corporate objectives.

Underwriting cycle (Soft and Hard phase) effect the profitability of an organization.

Firms makes strategy and launch a new insurance product and justify its costs by gaining profits

from other insurance products.

Critical mass – A business plan might well provide for a negative underwriting results,

particularly, during the early year of newly established firm, when expense will typically be high,

until the firms portfolio achieves the level of income necessary to support set-up, and other,

ongoing, costs.

Profitable growth is more important than profit because of maintaining control over cost and desire

of investors. The prevailing state of market must be considered by insurers in order to develop a

strategy for market share.

The underwriters will have to take such decisions which looks ridiculous but necessary for an

organization e.g. When fixed costs are taken into account it might be necessary to accept business at

lower premiums in the short term, even if the results is an underwriting loss.

MARKET SHARE AND PROFIT

Internal tensions e.g. failure to communicate the strategic objectives and

business plan throughout the entire firm may result in negative and collective

efforts are required.

New entrants in insurance market can produce drastic results because of the

market competition, critical mass point and expense ratio.

New entrants require a strong nerve for starting a business in competitive

environment.

THE UNDERWRITING CYCLE

Higher Profits

Higher Prices (Increased investments)

(Reduced competition) Higher capacity for that class

Capacity withdrawn (Increases Competition)

Lower prices

Lower profits or losses

THE UNDERWRITING CYCLE

Main factors which effect the cycle:

Insurers are interested in limiting the effects of cyclical influences on their

profitability and solvency margins and it can be achieved through selective

underwriting but it is always not practicable in the competitive market.

Economic cycles (Including effects of recession & level of investment return)

Political influences

Weather related claims

Changes to legislation or judicial decisions, resulting in new liabilities

MAJOR EVENTS AND TRENDS

External influences on underwriting strategy:

Economic trends – Country has its own economic trends which effects the insurance

cycle and underwriting strategy e.g. Inflation increase property value and so does the

sum insured. Similarly, theft claims increases due to unemployment.

Political Influences – Global conflicts effects economy and insurance cycle e.g. In

world war п oil price inflated and this in turn decreases vehicle use and so improved

the claims experience and it results in lower premium. Similarly, terrorism has effected

the availability of reinsurance and so has an impact on personal and commercial line

market.

Economic trends & Political Influences Weather related events

Long term industrial disease Pandemics & emerging risks

MAJOR EVENTS AND TRENDS

Weather related claims – In travel insurance a hurricane effects the person

negatively in USA.

It is also an important consideration for construction insurers in respect of physical loss or

damage and delays to project and contracts. Business interruption policy due to can

cause a great expense.

E.g. Storm and flood (Catastrophe places pressure on insurers’ and reinsurers’ capital

requirements to underwrite a business. Weather has far reaching effects on insurer,

therefore, insurer should consider the weather related claims in the formulation and

management of underwriting strategy e.g. Flood in Pakistan and Hurricanes in USA.

MAJOR EVENTS AND TRENDS

UK has introduced Climate Change Act 2008 and the key components are:

• Improve carbon management, thereby helping the transition for low carboneconomy

• Demonstrate strong UK leadership internationally for commitment towards itsresponsibility for reducing global emissions.

Subsidence in UK is also a concern for insurance industry, therefore, experiencedand selective underwriting with high excesses is required. The cost of claims fromsubsidence has fluctuated, primarily in line with the incidence of dry and wetsummers. Remedial measures such as, removing nearby trees and remedyingseepage from damaged underground pipes is taken, followed by monitoring andrepair, as appropriate.

Provision of cover for natural perils, such as flood and storm, in many countries arethe responsibility of the government e.g. Japan, USA.

MAJOR EVENTS AND TRENDSLong-term industrial diseases - Asbestos related diseases and Mesothelioma effectsemerges after a long time of contracting a diseases during employment. El insurancerespond to this but it may possible when diseased employee after leaving the job cometo know about the disease, the employer has ceased the business or record of relevantemployee may have been lost or destroyed.

So, the UK government and insurance industry through ABI have made arrangements todeal with such situations as mentioned above.

Pandemics and Emerging risks – Pandemics is an illness, disease or medical problemspread over a very wide area, crossing international boundaries and affecting manypeople e.g. influenza in 1918, claimed 20 m human lives. Similarly, H1N1 virus, Avian fluvirus which spread through migrated birds has crossed the borders of many countries.

The emerging risks like travel delay or abandonment due to volcanic eruption, Earth –quake, B.I, and live stocks are difficult to quantify and therefore little or no coverage isavailable in the market. So, insurers must monitor such emerging risks for the provisioncover by using strategy.

MAJOR EVENTS AND TRENDS

Volcanic eruption – Occur from the movements of tectonic plates, resulting in

the escape of hot magma, ash and gases from below the planet’s surface with

devastating effects e.g. travel disruption (Previously, not cover in travel

insurance policies but now some insurers are providing this cover) results delay

and travel abandonment etc.

Earthquake – Occurs when there is a sudden release of energy in the earth’s

crust, causing the shaking and, sometimes, fracturing of the ground surface.

Tsunami – When the source of a large earthquake is offshore a tidal wave (or

tsunami) can occur, with catastrophic results.

Just think about Karachi in Pakistan

MAJOR EVENTS AND TRENDS

Contaminated land – Industrial processes or activities present a

hazard to the general environment. The awareness about environmental

pollution has got attention of legislators around the globe and so insurer should

consider developments in environmental legislation and associated liabilities for

polluters, owners, and occupiers of the land.

Specialist markets are providing specialist cover for pollution known as

Environmental Impairment Liability (EIL) insurance, the cover provided by

general liability policies is still typically restricted to sudden & unforeseen events.

Similarly, material damage property policies provide cover limited to pollution

or contamination resulting from the operation of an insured peril under the

removal of debris clause.

LEGAL CHANGES

Legal changes and case law have impacted on the insurer’s liabilities, and its results.

Funding litigation – Has introduced the facility to recover legal expense insurance

premiums and success fees from opponents, and removing them from the scope of

legal aid, except for clinical negligence actions.

ATE and BTE legal expense insurance (Knowledge services – fact files) –

www.cii.co.uk

LEGAL CHANGES

Periodic Payment Order (PPOs) – Lump sum payment to injured person has not

proved beneficial due to life expectancy or the poor investment return, advice, under

performance or even failure of the investment fund.

Social Security Act 1989 introduced structured settlement which are used where the

injured require a long term care and so claimant receives a payment to meet their

immediate needs, together with periodical payments (Insurer or reinsurer purchase

annuity or pay itself) to provide income for future provision and care.

Courts Act 2003 - Court can now order periodical payments.

Discounts rates – Assumed rate for payments should be aligned the return on

Government bonds (GILTS), which provide a more modest expectation than the more

volatile share prices because of poor investments results on which the injured party is

dependant.

MARKETING STRATEGY

Marketing mix - Product, Price, Place, Promotion (Decision of marketing based on

PPPP).

2 Main types of distribution channels for insurance:

• Direct – Insurer’s employees sell the insurance product or direct mailing techniques are

used to promote sales e.g. Direct marketing, Co. sales staff, Home service agency (sell

industrial life assurance only), internet.

• Indirect - Intermediaries paid by the insurer promote products on insurer‘s behalf e.g.

Agents, brokers, consultants & advisers. Use for Complex products.

Scheme & delegated authority – Insurers delegate some authority to intermediaries e.g. to

issue motor cover notes, within defined given criteria.

Binders – Give a great deal of flexibility to intermediary within defined limits & policy

wording have been specially negotiated to fit a particular client category e.g. haulage

contractors, warehouse keepers, etc.

MARKETING STRATEGY

Aggregators collects information from different data sources like search

engines on the internet. Market aggregators rely upon co-operation with brokers

& insurers to access their pricing of different risks. Aggregators affect the

accuracy of the quotation as limited questions asks from the aggregators for

quote. They are consumer focused priced comparison mechanisms rather than

the distribution channels and save time.

Impact of pricing models – Expenses, commission rates and business

retention effects the pricing models. Underwriting & pricing of models differ for

direct (incurs high acquisition costs) and intermediary business.

Intermediary’s remuneration (delegated authority or direct administration), claims

experience, pure price of risk, additional expenses and optional modification

effects pricing models and so to the business strategy.

MARKETING STRATEGY

Branding (Has the power) – Key aspects of marketing and use of image of

quality, reliability or service, forged by the personal experience of the product,

recommendation or simply an affinity developed by familiarity with the name of

the product or provider. This affinity is at the heart of advertising and as a result

“Product loyalty” created.

Regulation

Taking account of the requirements of the industry regulator is a key

consideration in distribution activities.

MARKETING STRATEGY

Underwriting control

Nature of underwriting control varies according to the chosen distribution

method. Auditing of employed staff is necessary.

Centralised underwriting functions will have responsibility for exercising control

over the technical aspects of the insurer’s operation, with responsibility for

things as, e.g., setting underwriting policy, maintaining rating and underwriting

parameters, including authorisation (and sometimes implementation) of rating

changes.