25.4 Insurer Op Risk: Cycle Management

Definition 25.2 (Cycle Management) Prudent management of u/w capacity as market pricing fluctuates in the u/w cycle

• Simply maintaining market share during soft markets increases the likelihood of impairment

3 questions to ask:

1. Does the company have a proactive cycle management strategy? (if not, need?)

   • e.g. if we reduce rates (or increase exposure for the same premium) during soft market, it’ll lead to increase reserve down the line

2. Does the company know where in the cycle the market stands

3. Are u/w-ers making decisions that are consistent with (1) and (2)

25.4.1 System Performance Perspective

Assess an insurance company from a system performance perspective, it needs to be:

• Stable and available

  • Downgrade impacts this

• reliable and affordable

  • Insolvent impacts this

25.4.2 Performance Improvement via Cycle Management

Areas impacted by implementing cycle management:

• Planning, u/w, objective setting, incentive bonus

Focus on the following to achieve meaningful process improvements:

• Intellectual property

• Underwriter incentives

• Market overreaction

• Owner education

25.4.2.1 Intellectual Property

Majority of an insurer’s franchise value are intangible

• They time consuming to build but easy to destroy

IP examples:

• Experts in various functions (e.g. u/w, claims, finance, actuarial)

• Proprietary database

• Forecasting systems

• Market relationship

• Reputation

Focus on retaining these core assets through cycle:

• Retain top talent, grow and develop their skills

• Maintain presence in core market channels

• Maintain consistent pattern of investment in systems, models and database

25.4.2.2 Underwriter Incentives

Bonus should be based on u/w-er supporting the portfolio goals throughout the year

• Which may include writing less business

• U/w-er should know that it won’t affect employment and bonus

25.4.2.3 Market Overreaction

Industry tend to overreact (taking prices too low and too high)

Companies with most capital during price-improvement phase will reap windfall profits

• Which will more than offset many years of small u/w losses

25.4.2.4 Owner Education

Educate owner/shareholders on the impact of cycle management on financial figures

Will be out of step with the market and does not appear healthy during soft markets:

• Premium volume \(\downarrow\)

  • Need to understand that growing exposure when the price is not adequate is not prudent

• Overhead expense ratio to premium \(\uparrow\)

  • Typically a metric for efficiency, but should be focus less

  • See this as capital investment in the assets of the firm and they will provide benefits to the firm in the future