By Tony Buckle and John Carolin | December 16, 2023
This article, was first published in Carrier Management on December 12, 2023.
On the face of it, it appears to be a good time to be an underwriter. A combination of historic underperformance, an elevated risk outlook and investor reticence is encouraging underwriters to push the envelope in terms of information requirements, policy conditions and pricing demands. It’s hardly the time to worry about key performance indicators (KPIs).
In this article, we challenge this assumption. Focusing on underwriting, we argue that now is precisely the time to revisit KPIs—not just for the here and now but across the market cycle. Otherwise, ineffective KPIs run the risk of actively undermining the very discipline and technical frameworks that management have established to ensure their firms’ financial sustainability.
Our basis is research we recently conducted into specialty underwriting during a very different phase of the market cycle: the softening market that reached its nadir in 2017.
With the support of the International Engineering Insurers Association and SBS Swiss Business School, we surveyed the global community of Engineering and Construction underwriters to understand why they continued to write the risks they did during that period—when precisely the opposite conditions to today prevailed. (See related article, published by Carrier Management in October.)
The research found that the underwriters were not “unconscious or unaware” of market conditions. Conversely, underwriters were very much aware they were in a soft market and could foresee that terms were likely to deteriorate further. They also were clear that their ability to modify terms for the better was negligible. On the balance of probabilities, they knew they were likely to lose money but were unwilling to act.
“I have been in the business for over 30 years, and it was a very frustrating period because I saw history repeating itself in an even worse way than before.” — senior underwriter at U.S. global insurer, surveyed by UWX.
To their credit, the underwriters do not ascribe their subsequent poor results to bad luck. They knew they were playing with fire. Another noted, “we knew it and we [still] did it.”
In Part 1 of this two-part series, we discussed motivations and the role played by market peer pressure as well as client and broker encouragement and management goals. These pressures lead to thinking such as: “We knew terms and conditions were not good but the competitors wrote it if we did not” — senior underwriter at global insurer in Germany.
In our view, a key first step to overcoming this structural flaw is recognizing these pressures exist. As with all professionals, underwriters put pressure on themselves to perform and they define “performing” via internal and external reference points. So, it is vital that management recognize and assess these different pressures and that targets being set reflect that assessment.
In a hard market, the stars align: management’s desire for profitability, underwriters’ desire for professional peer recognition, and clients’ and brokers’ desire to offload unwanted risk can all be served at the same time.
In a soft market, however, when insurance terms and conditions are broadly inadequate, it is difficult to serve clients and be prominent in the market and still turn a technical profit from underwriting.
Long-Term Performance Measurement and Goals
This brings us to the need for companies to enact long-term performance measurement and goals. If management does not explicitly target underwriting discipline, the evidence suggests underwriters cannot impose it themselves. While underwriters might seek to challenge goals that are overly ambitious, poorly conceived or both, management should not be surprised if underwriters find ways to achieve them once they are set.
External factors—such as keeping up with one’s market peers and satisfying clients and brokers—encourage a “bias to place” in the commercial insurance market.
And even internally, if discipline is not explicitly targeted, underwriters can feel that they need to produce in order to “get ahead.” In the survey, respondents agreed that they wrote business to win internal recognition and reward.
Targets Matter
Nature abhors a vacuum. It is not so much “what gets measured gets done” as “what gets measured gets prioritized.” The survey response flagged that when senior management does not explicitly communicate the need for discipline in the soft market and set performance targets accordingly, other priorities will prevail. Targets really matter. So, if you want different outcomes at different stages of the market cycle, the substance of what is being targeted needs to change, not just the quantum.
For example, many companies set premium income targets. But what is premium? Premium is essentially the (current) price of risk. Assuming all other factors remain constant, any increase in premium implies a commensurate increase in the risk being taken on.
In a hardening market, prices may well increase irrespective of the underlying risk profile. In such a scenario, it makes perfect sense to target premium increases year on year. In a softening market, however, where the prices being charged for risk transfer are falling, even maintaining premium levels year on year implies more risk transfer—for example, by increasing one’s share of risks being offered. And in the depths of a soft market, when actual prices being charged are broadly below the “technical” prices that the risks demand, increasing premium presages larger underwriting losses.
If underwriting profitability is the goal, then premium targets should be reduced in soft markets to enable underwriters to exit business where premiums are inadequate. In the same way, setting targets for new business makes sense in a hard market but much less so in a soft market. Indeed, management might want to put additional controls around any new business taken on at this stage of the market cycle.
“In a soft market, low broker net promoter scores may reflect underwriters showing their mettle.”
Another popular metric that needs to be reassessed is broker net promoter score (BNPS). In a hard market, carriers should target a positive BNPS and address any frictions that exist between underwriting and their trading partners. In a soft market, however, carriers may want underwriters to “draw the line” by maintaining discipline in the face of broker pressure. Low BNPS scores may reflect underwriters showing their mettle. (A broker net promoter score measures broker ability and willingness to use a particular carrier relative to its peers in the sector. So, if underwriters pulled back from the broker in a particular line due to inadequate terms, the broker net promoter score would decrease. UWX research has found that carrier senior management at times used these scores in the soft market to challenge underwriters as to why they were not writing more of the broker’s business. Over time, this undermined underwriter discipline.)
Another KPI that carriers need to reassess over the cycle is cost ratio. Costs tend to be relatively fixed over the short term, so the real variable in the ratio is not the numerator (cost) but the denominator (premium). As it is far easier to write some more premium than further reduce costs, underwriters are often encouraged to write more premium to dilute the cost ratio in a soft market. This is perverse behavior in a softening market, where underwriters are often struggling just to maintain year-on-year premium rates.
Managing the Expectations Cycle
So, what can be done?
A positive first step is to move to anchor KPIs in data that is not cycle dependent such as technical price. We accept that such measures will always be partially subjective, but they can be usefully objectified with market data, tools and benchmarks. Aligning premium targets to technical rate adequacy, for example, means that the KPI is focused on premium quality rather than premium quantity. This would serve to act as a natural accelerator and brake. If the market price is well above technical price, underwriters can write opportunistically, whereas if actual prices fall below technical prices, capacity can be reduced or pulled out of the market. While shares are often reduced in a soft market—due to such rampant competition—sometimes insurers actually have to make the tough decision to get out of the underperforming business altogether.
A second positive step is to define and agree which performance metrics the carrier will track over the cycle (and which will not be tracked) and how they will be assessed. These will vary by line of business and on an account level; strategic and cross-class considerations will need to be factored in. In all cases, however, it should be pre-agreed which factors weigh more in the performance scorecard at which stage of the market cycle.
The third and potentially most important step of all is to pre-agree the governance framework. In most scenarios and for most accounts, this can extend to the specific actions that management and underwriters are to take if and when particular triggers are tripped. Pre-alignment and transparency here—between investors, managers and underwriters—enables strategic portfolio management over the cycle. It will also empower managers and underwriters to act with confidence and manage client and broker expectations as to their appetite for risk.
Memories of recent underperformance combined with current strong results provide insurers with a window to reframe performance frameworks with key stakeholders, both internal and external. We believe that adjusting KPIs to reflect the market cycle will serve to limit the excessive price swings that commercial markets have recently seen. A key benefit of this would be to enable commercial insurers to offer more consistent terms and conditions to their clients and help build sustainable and dependable long-term relationships.
