With considerable uncertainty over prices and conditions in the commercial insurance market, insurers need to be prepared to walk away when prices fall below a prudent, risk-based premium level, the Lloyd's market advises.
That counsel is contained in the Lloyd's report, "Managing the Insurance Cycle," which contains various recommendations–including providing the right incentives for underwriters, and investing in risk management tools.
Lloyd's cautioned that in the softening market cycle, as prices decline to the point that profits diminish or vanish completely, capital needed to underwrite new business is depleted, and insurers that have not underwritten prudently can lose millions. Besides not following the herd, investing in the latest risk management tools and being smarter with underwriter and manager incentives, the report recommends four other key steps to ensure that the industry becomes less unpredictable.
The steps are:
o Don't let surplus capital dictate underwriting. Lloyd's noted that an excess of capital can push an insurer to deploy the funds in unsustainable ways, rather than having it migrate to other uses–such as hedge funds and equities, or returning it to shareholders.
o Don't be dazzled by higher investment returns and forget disciplined underwriting as rates creep up. Split the business into insurance and asset management operations, and monitor each separately.
o Don't use a spectacular insured loss 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.
o Redeploy capital from lines where margins are unsustainable.
Rolf Tolle, Lloyd's director of franchise performance, said with rates softening in a number of lines, "we believe that it is now more important than ever for insurers to take action. We have already done a lot of work on this at Lloyd's to encourage underwriters to manage the cycle, but the real test of a soft market is still ahead of us and there remains much to be done."
Lloyd's said it commissioned the report from the Economist Intelligence Unit as part of its 360 Risk Project, which aims to generate debate about today's key risk issues and how best to manage them.
Concerning risk management tools, Lloyd's said insurers should 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 pricing and coverage decisions.
Lloyd's said that while there is little that individual insurers can do to alter overall supply-and-demand conditions, they 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.
The full 19-page report, including an executive summary, can be seen at www.lloyds.com/360.
According to the Lloyd's analysis, markets with rising prices tend to be shorter than markets in which prices are falling.
The report's look at U.S. insurance market data shows that over the period 1970-to-2005, the average hardening market lasted for 3.25 years (peak to trough), while the softening market lasted for 4.75 years (trough to peak).
This pattern of shorter peaks in pricing followed by longer troughs is driven by the supply-and-demand conditions of the industry, and in particular the oversupply and interchangeability of capital, according to said Lloyd's.
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