This article first appeared in Forbes online on 12 October 2023: https://www.forbes.com/sites/forbesbusinesscouncil/2023/10/12/how-insurance-teams-can-combat-herd-behavior
by Rita Trehan, Forbes Councils Member, Forbes Business Council
Rita Trehan is author of Unleashing Capacity and Too Proud To Lead, a Forbes Business Council member and founder and CEO of Dare Worldwide.
An opinion article published in the New York Times in July argued that California and Florida have become “almost uninsurable.” The Washington Post said there is “an insurance crisis.” Insurers are “hurting,” according to Reuters. This means some corporates could be struggling to get the insurance they need.
I’ve seen commentators often blame the changing risk environment. Climate change, tort reform and social inflation are obvious concerns. But I believe there is a more fundamental factor that is also driving the scarcity of insurance capacity: the recent financial performance of insurers and reinsurers. Property/casualty insurers in the U.S. endured a nearly $27 billion underwriting loss in 2022, Insurance Journal reported.
I have witnessed firsthand the challenges sectors like insurance face. In my role working in the energy sector, I had a lot of experience in understanding project financing and captive insurance and have had clients in the past who are responsible for private insurance. Further, as an executive within listed public companies and as an advisor and author, I have seen how culture, leadership and values drive continued renewal and growth—or an unraveling that can prove costly and sometimes irrecoverable. Business cultures need to be dynamic, adaptive and ready to adjust.
Herd Behavior
Corporate and specialty insurance lies at the customized end of the insurance market. Large companies (and their risk profiles) tend to be heterogeneous and dynamic. The elevated risk demands the purchase of high limits, and this part of the market is often characterized by high volatility. The rewards can be great, but single losses can also be very expensive.
The inherent volatility is exacerbated by the market cycle. This is well-established; there are periods of market hardening, such as now, and periods of marketing softening. In my experience, capital is often considered the cause of this cycle. This assumes, however, that human actors play a subordinate role at most in shaping the market.
I believe a recently published study (paywall) in Carrier Management challenges this assumption. (Full disclosure: I helped advise on the survey’s design and provided access to a survey-hosting platform.) The study was conducted by Tony Buckle and John Carolin, co-founders of insurance consultancy UWX, and surveyed 120 engineering and construction underwriters from 31 countries between 2013 and 2017. The goal of the research was to uncover underwriters’ motivations during the soft stage of the market cycle during this time.
From my view, the study stresses the importance of the behavior of key decision-makers—not just the actions of senior leadership teams, who set the performance goals and cultural tone of their organizations, but also underwriters, who make the transactional decisions. It was clear from the underwriters’ responses that they were aware they were working in a soft market and that their terms and conditions were inadequate; they knew they had little ability to change the terms, and they recognized the trend in terms was toward continued deterioration.
Why did the underwriters accept such risks? They wanted “to be recognized as a player in the market, to serve brokers and clients, and to achieve management performance targets.” They also felt “disempowered” to change the terms and conditions, and they didn’t feel they could challenge performance targets set by management.
Lessons To Learn
I think the study highlights that underwriters want to be recognized and respected members of their communities capable of delivering in tough situations. This need may push them to make compromises with respect to the business they are accepting. Secondly, short-term goals and incentives may sometimes trump long-term ones, perhaps particularly when one’s profile in the broader market community is important to career progression.
Bringing these two points together, to address the type of herd behavior the study profiled, management teams need to actively align goals with the realities of the market environment. What can you do practically?
In discussion with the chief underwriting officer and the board, clearly define which stage of the cycle the insurer finds itself in while bearing in mind that different products are unlikely to be completely in sync. Based on this understanding, adjust targets proactively to ensure both the long-term interests of clients seeking sustainable protection and investors seeking sustainable returns are protected.
As boards of directors are charged with ensuring the interests of all stakeholders are protected, they bear a responsibility to question, probe and challenge senior leadership as well. Use internal and external data to challenge assumptions being made in the planning cycle and in target setting. Confronting inertia is no small task. In my experience, this requires listening not only to what people say but also how they say it and looking at what they then do.
Furthermore, recognize the need for both diverse experience and deep functional expertise at both the leadership level and on the board of directors. This combination of experience and expertise could encourage front-line workers such as underwriters to be more transparent about current market conditions and trends and their ability to navigate them profitably.
Final Thoughts
For investors in the insurance sector, perhaps the most important lesson to draw from the above is that you must be active, even activist, in managing your investments. The cycle changes the game fundamentally. When the market softens, investors should be challenging management to focus on the underwriting discipline. I believe this would underpin market stability, serving the long-term interests of commercial insurance customers and challenging cultures where senior management might pay lip service to technical underwriting. Get the culture right, and the results will look after themselves.