Dealing with insurance cycle

While many underwriters believe that the cycle is out of their hands, Lloyd’s is trying to push for more proactive management of the ups and downs of the industry. In 2006 they published their

‘Seven Steps’ to managing the insurance cycle:

  

1. Don’t follow the herd. Insurers need to be prepared to walk away from markets when prices fall below a prudent, risk-based premium.

 2. Invest in the latest risk management tools. Insurers must push for continuous improvement of these tools based on the latest science around issues such as climate change, and make full use

of them to communicate their pricing and coverage decisions.

  

3. Don’t let surplus capital dictate your underwriting. An excess of capital available for underwriting can easily push an insurer to deploy the capital in unsustainable ways, rather than having that capital migrate to other uses such as hedge funds and equities, or returning it to shareholders.

4. Don’t be dazzled by higher investment returns. Don’t let higher investment returns replace disciplined underwriting as base rates creep up on both sides of the Atlantic. Notionally, splitting

the business into insurance and asset management operations, and monitoring each separately, is one way to achieve this.

  

5. Don’t rely on “the big one” to push prices upwards. The spectacular insured loss should not be used as an excuse to raise prices in unrelated lines of business. Regulators, rating agencies,

and analysts – not to mention insurance buyers – are increasingly resisting such behavior.

6. Redeploy capital from lines where margins are unsustainable. There is little that individual insurers can do to alter overallsupply-and-demand conditions. But insurers can set up internal monitoring systems to ensure that they scale back in lines in which margins have become unsustainable and migrate to other lines.

7. Get smarter with underwriter and manager incentives. Incentives for key staff should be structured to reward efficient deployment of capital, linking such rewards to target shareholder

returns rather than volume growth. The Lloyd’s Managing Cycle report has several problems. It focuses on the industry as a whole being able to work together to reduce the effect of market

fluctuations. However, this is somewhat unrealistic, as if underwriters do not write business in a soft market (i.e. at cheap prices for the customer), it will be hard to win this business back in a hard market due to loyalty issues.

Rolf Tolle asserts that “There is nothing complex about the cycle. It is about having the courage of your convictions to act with strength.”. Swiss Re argue that instead of ‘beating’ the cycle,

insurers should learn to anticipate its fluctuations. “Cycle management is essentially proper timing. Monitoring the market, predicting market trends and accurately assessing prices play an

important role”.

Swiss Re give several examples of potential business strategies. One is to write risks at a roughly fixed rate. This is clearly not practicable as it does not allow for the cyclical nature of the market.

Another is to fail to react fast enough to changes in the market, which leaves a company even more exposed. The recommended strategy is one that relies on prediction of the business cycle

and setting premiums based on models and experience.