From the agent's perspective, companies are cash-flow underwriting. Why else would a company discourage agents from achieving low loss ratios? Yet it's happening. As shown by the following actual examples, these carriers clearly are sacrificing loss ratios for growth:
o A contingency contract that pays $0 for a 10 percent loss ratio and 0 percent growth on $1 million premium, but pays $25,000 for a 50 percent loss ratio and 4 percent growth
o A contingency contract that severely cuts bonuses for books with low loss ratios and increases bonuses for books with marginal loss ratios
o Advising agents with less than 3 percent growth and sub-20 percent loss ratios that they are not performing adequately.
The problem with carriers focusing on growth while sacrificing loss ratios is best shown by the following comparison:
Agency's book with Carrier A
o $1 million premium
o 40 percent loss ratio
o 35 percent expense ratio (carrier's actual expense ratio)
o 0 percent growth
o Carrier A earns a 25 percent profit on this book.
Agency's book with Carrier B
o $1 million premium
o 55 percent loss ratio
o 37 percent expense ratio (carrier's actual expense ratio)
o 5 percent growth
o Carrier B earns an 8 percent profit on this book.
Is growth really worth so much less profit? Obviously, some carriers have decided $1 of growth is worth 68 percent less profit.
The calamity of focusing entirely on fast growth is that loss ratios eventually will increase across the industry. Results already show the initial stages of this trend. Once loss ratios trend up, profits eventually will fall substantially. I don't know anyone experienced who believes the industry will maintain underwriting discipline better than it has in the past. Once loss ratios rise, carriers must re-underwrite and raise rates to stay afloat--but re-underwriting and raising rates both lead to lost business.
By the time the loss ratios and poor profits catch up, a new CEO is usually on board and the new CEO and the old CEO can both claim victory. The retiring CEO will talk about the great growth he achieved and the new CEO will claim the profitability he will engineer.
This is the fundamental flaw agencies see--and it is the flaw many successful insurance company CEOs exploit year after year. These CEOs understand their fellow CEOs are too short-sighted. They know slow, steady and profitable growth is the better long-term strategy. Meanwhile, their weaker brethren constantly announce changes that will make them even more successful, i.e., "What we've done so far isn't working."
The counter argument I've heard is that in this extremely soft market (the industry has lost 5 years of growth--total commercial lines net written premium is now less than it was in 2003), if the carriers' pricing isn't aggressive, they'll have nothing left to underwrite, and loss ratios won't matter. But this overlooks an important point. Good underwriting agents almost always have a core book of small to medium accounts, especially personal lines accounts that aren't going to move. Punishing these agents for not growing, when these same agents are maintaining profitable books, is cutting one's nose off to spite his face. This is an extremely mature industry in an extremely mature economy. Growing fast responsibly is not possible without an unending supply of new equity, and I only know of one carrier of any size that achieved this annually over the last 10 years.
Agents who understand the long-term benefits of moderate but profitable growth wish all of their carriers would follow the path of the most successful: Steady but moderate growth relative to industry-wide growth, achieved by rewarding agents for strong profits, rather than just growth. Perhaps most importantly, in an industry that tends to hold down rates long past the time they need to rise--because no carrier wants to be the first to raise rates--more profits build stronger balance sheets, assuming smart financial management. This enables the more profitable carriers to be the last to have to raise rates, creating a fantastic opportunity to gain significant market share.
This is a key point. Gaining significant market share in a soft market can hardly be done without irresponsibly cutting rates. The best time for agents and carriers to gain profitable market share is in a hard market, and this is best achieved when patient preparations are made in a soft market. Since hard markets are much shorter than soft markets, agents and carriers have to be ready to strike when the opportunity presents itself. Sounds like a winning solution for everyone!
