Repositioning Claims in Non-Life Insurance (Market Focus)

Content

• Catalyst
• Summary
• Methodology
  • AnaLYSIS
  • Strong financial performance in global non-Life insurance
  • Strict underwriting practices: While healthy premium gains have• driven top-line growth, more selective underwriting has helped keep insurers manage risk, contributing to lower expense and claims ratios. Insurers raised rates dramatically on nonstandard, or high-risk policies, creating a high-margin balance, or neglected this business altogether, resulting in a much higher-quality book of business. The introduction of more sophisticated rating and segmentation techniques have improved efficiency in the underwriting process, and these practices are now showing evidence of distinct competitive advantage for some carriers. US property and casualty insurer Allstate, whose Strategic Risk Management (SRM) program targets "high-value" underwriting opportunities and prices all risk according to an expanded group of measurements that are continuously reincorporated into future decisions, is among the insurers who have distinguished themselves with better underwriting techniques. Many of the largest non-Life insurers on both sides of the Atlantic, including Progressive, Allianz and mutual companies such as State Farm have implemented similar programs that are expected to allow them to maintain better risk profiles, while providing other benefits, such as higher retention rates.
  • Higher surplus; higher reserves: The combination of stronger• underwriting performance coupled with an economic rebound and rising stock valuations has allowed insures to build significant policyholder surplus, or the amount set aside after operations for losses. Along with business and "shareholder value creation" initiatives, such as acquisitions and stock repurchase plans, insurers have been able to use this cash to build strong reserves. The decision to fortify reserve positions emerged several years ago as the industry was bracing for a series of class-action lawsuits for a number of liabilities, including asbestos exposure, mold, and tobacco-related illness. Stronger reserve positions have in turn resulted in strong ratings for non-life insurers which has helped the industry attract new capital.
  • Favorable claims trends: The cost of claims, which in total• represent anywhere from 70-85% of an insurer's operations, have been held in check by favorable frequency (number of claims) and to a lesser extent, severity (cost per claim) trends. Improvements in car safety, declining theft, tougher drunk-driving and speeding laws, as well as indirect factors such as an economic downturn, which reduces the amount of commercial and residential vehicles on the road, have been among the secular trends driving down incidents. Although the cost of claims has not declined in recent years as has the number of claims, the cost is growing more slowly. There are signs this trend may be ending, however, as increased catastrophe, more expensive vehicles, and more litigious drivers, have contributed to rising claims costs in recent years.
  • Market factors contributing to a softening cycle
  • Competition is intensifying: The traditional approach has been• to reduce rates and loosen underwriting standards to retain exist market share, and increase exposure to capture new premium. A handful of companies have even chosen to raise rates in order to offset rising costs, as Norwich Union has recently announced. In the context of non-life insurance, this is a counter-intuitive strategy in a price war and depends on strong retention rates to keep premium growth from declining. Strong customer relationships are critical, something to which many non-life insurers are unaccustomed.
  • Premium rates remain in decline: Despite the recent strong• performance and operational discipline in global non-Life insurance, premium prices have been in slight decline since 2004, indicating the onset of a mild "soft market" in non-Life insurance. Figure 1 highlights the decline in premium growth beginning in mid-2004, and occurring in both commercial and personal lines. Renewals on commercial policies in the US are down roughly 5% in many markets, while personal lines in both auto and homeowners are flat to slightly down in both the US and Europe. Other factors impacting global economies, including rising interest rates and mild slowdown in economic growth, have also adversely impacted premiums. Although these declines have largely occurred in selective markets, and underwriting discipline has limited large losses and kept combined ratios low, the threat remains that the industry will revert to more "irrational" practices, with riskier "non-standard" business increasingly underwritten to maintain market share and keep gross premiums at high levels.
  • Catastrophe losses have severely tested the industry: In the US,• the 2004 and 2005 hurricane seasons were a severe blow to insurers' and reinsurers' profitability. In 2005, a year headlined by the devastating Katrina, property and casualty insurers suffered over $60 billion in insured losses, with many commercial as well as personal claims contributing to the damages. Ratings agencies in the US downgraded the entire industry, and reinsurance costs spiked dramatically, while state-by-state consumer protection regulation largely prevented insurers from passing these higher costs along to policyholders in regions not affected by the storms. To the surprise of some industry watchers, non-life carriers displayed remarkable resilience. Large reserves built up over the past several years greatly ameliorated the impact, and likely prevented some carriers from going under. On the first anniversary of Katrina, approximately 95% of the industry claims had been paid, underscoring the financial health in non-Life insurance built up in the previous half-decade. Nevertheless, two successive years of high catastrophe and a forecast of a severe 2006 hurricane season sent a shock through the industry and reminded it just how vulnerable it is to large instances of catastrophe. The industry seems to have accepted a more unpredictable and dire future that includes the potential for increased incidents of extreme natural disaster as well as man-made disaster in the form of terrorism.
  • Compliance costs are rising: Regulation in the US remains• largely the responsibility of individual states, a system that for years has been criticized as an impediment to competition among regional and national carriers, who suffer from long product launch times waiting from approval from multiple jurisdictions. While the State Modernization and Regulatory Transparency Act (SMART) has seen the most attention over the past 2 years, with many viewing the proposal as a good first step towards standardization, an optional federal insurance charter (OFC) is getting more attention going into 2006. With a unified front some way away, other alternatives, including a "life-only" OFC - incorporated onto the existing SMART proposal -- are gaining attention, however reaching a consensus still seems unlikely in the short term. The implementation of Sarbanes-Oxley and other federal regulations are forcing insurers to increase spending in areas such as storage-management software, document-management systems and backup and recovery systems in order to remain in compliance with the law. These initiatives will add a significant cost of requirement to the entire financial services industry. Meanwhile, new FSA regulation will impact all stakeholders in the insurance market. Datamonitor estimates that this regulation will cost the insurance industry 200 million to become compliant, and an additional 160 million on an ongoing annualized basis.
  • Non-life insurance is again targeting claims-related issues
  • Higher costs are again creeping into the industry
  • Fraud
  • Leakage
  • Beyond cost control: Claims emerges as central to a broader business strategy
  • The benefits of reducing claims leakage are well-understood within the insurance industry - lower costs and satisfied claimants. Because of the central operational position claims holds within an insurance operation, improvements to claims systems are increasingly being seen as a way to address broader market trends and support business strategy.
  • Insurance is becoming a customer-focused business
  • The claims process as data management opportunity
  • Insurers have increased IT spending to help support these imperatives
  • Conclusion: As the heart of non-life insurance, claims' strategic importance is growing
• Appendix
  • Definitions
• Further reading
  • Ask the analysts
• List of Figures
  • Figure 1: US P&C Premium Growth and Combined Ratio
  • Figure 2: The Underwriting Cycle