The London Insurance Market Evolution not revolution€¦ · challenge of developing marketing,...

INDUSTRY VIEWS

The London Insurance Market

Evolution not revolutionMaintaining the competitive position*

Contents

Introduction: CEO perspectives01 2-9

Executive summary02 10-17

Underwriting, distribution and aggregation management03 18-47

Claims at a premium04 48-63

London Insurance Market05 64-65

Contacts06 66-67

Introduction: CEO perspectives

01

Evolution not revolution • PricewaterhouseCoopers • p3

The ability of London Market

insurers to respond to fresh

challenges, including the issues

thrown up by 2005’s record

insurance losses, has been at

the fore over the past year. Most

companies are confident about

their financial prospects for 2006.

Yet how safe are they from another

round of major losses and how

sustainable is their global position

in the face of ever-increasing

international competition? As part

of this year’s London Insurance

Market survey, we asked chief

executives from a cross section of

businesses and organisations to

share their perspectives on the key

challenges and opportunities ahead.

Among the great virtues of the

London Market is its resilience.

Despite the setbacks of last year’s

US hurricane season, several leading

insurers posted excellent profits in

2005. Although others were forced

into the red, they entered 2006 with

their credit ratings confirmed and

ready to take advantage of

hardening rates in many of their

key classes of business.

Underwriting management

The CEOs we interviewed were

reasonably confident that their

revised underwriting strategies and

management processes will better

equip them to deal with today’s

risk environment and help deliver

strong returns in 2006. Their

businesses have recalibrated their

catastrophe models and realistic

disaster scenarios (RDS) to

address the volatile climatic

environment. They have sought

to reduce and diversify their risk

exposures. Underpinning all

these developments is stronger

management of aggregations, the

number one priority for CEOs in

our survey (see Figure 1 overleaf).

The result is what a CEO described

as a ‘closer and more effective set

of dynamics’ that helps to embed

the risk appetite within the daily

underwriting operations.

Yet, shades of doubt about the

outlook for 2006 remain. Several

CEOs expressed continuing

concerns about both the reliability

of, and over reliance on, catastrophe

and aggregation model results.

The efficacy of model analytics is

dependent on the quality of the

underlying data and assumptions,

which as our survey highlights are

still not always as robust as would

be hoped. Even when using a

single model, the range of the

possible results can be quite

broad. Given the limitations and

variability of the outputs, some

insurers may need to look more

closely at how to manage their

stakeholders’ expectations about

the interpretation and most

appropriate use of their model

results. ‘Models can offer no more

than guidance’, said a CEO.

The CEOs are therefore looking

closely at how to enhance the

quality, reliability and timeliness

of the data supply and resulting

Introduction: CEO perspectives

‘ For a Market that is supposed to be the speed boats compared to the super tankers, information moves too slowly and the response to developments in the Market is as a consequence too reactive.’ London Insurance Market CEO

01

p4 • Evolution not revolution • PricewaterhouseCoopers

analytical output. One CEO highlighted the importance of working with clients and intermediaries to improve the precision and organisation of data capture. In relation to property catastrophe exposures, this includes being able to source more extensive and granular information about the specific risk characteristics of particular buildings and their location.

Others discussed the need to improve data input, processing and turnaround to help speed up the production and resulting relevance of management information. ‘Being nimble and dynamic enough to allocate capacity as market conditions change demands very timely information’, said a CEO. ‘Yet it is amazing how slow we are if you compare our Market to the rest of the financial services sector.’

Effective monitoring of aggregations of exposure and optimised reinsurance spend

Achieving comparable underwriting performance to 2005 and institutionalising effective cycle management

Embedding capital and risk management within the day-to-dayrunning of the business

New markets (geographical)

Improved management information

Capital levels and allocation

New distribution channels

New markets (classes of business)

More effective management of regulatory burden

Improved finance function effectiveness

Improved cost control (excluding commission) to protect the bottom line

Improving claims service and claims cost management

Reducing commission levels, e.g. by unbundling services currently provided by brokers

Enhanced corporate governance

Increased level of direct contact with policyholders

Other 0.71

Mean score

A score of 5 is assigned to the highest priority issue, a score of 4 to the next most important and so on.

0

0

0.14

0.21

0.21

0.29

0.36

0.43

0.57

1.00

1.07

1.07

2.07

2.50

3.07

0 1 2 3 4 5

Source: PricewaterhouseCoopers 2006

Figure 1: Most important issues on the CEO’s agenda for 2006:

Introduction Continued


Several CEOs want to move towards real-time RDS analysis. If this is possible in a bank that has a multitude of fluctuating positions, why not insurers, they ask. Some feel that greater use of electronic data exchange as part of the peer-to-peer initiative could help to eliminate much of the delay and potential errors of manual processing. Such developments are clearly desirable if the London Market is to stay ahead of its international competitors.

Reinsurance

Insurers’ ability to optimise reinsurance expenditure and achieve consistently strong underwriting performance is being seriously impeded by soaring reinsurance prices, most notably around this year’s July renewal season. The fallout from the continuing withdrawal of retrocessional (‘retro’) capacity presents a particular challenge. Retro was described by a CEO as ‘surrogate capital that has enabled London to punch above its weight. So where will London be if retro goes?’ he asked.

Our survey revealed that the deployment of Alternative Risk Transfer (ART) instruments is rising. However, the proportion of reinsurance expenditure being redirected to the ART market is still small and some CEOs feel the return criteria may be too narrow to make up for the reduction in

availability of conventional cover. Another option would be to draw on the extra ‘side car’ capacity opening up in Bermuda, though concerns remain that such vehicles will not provide the continuity of cover of their traditional counterparts.

Insurers’ primary response to the pressure on reinsurance prices and availability has therefore been to accept higher retentions and to reduce their more volatile risk exposures. While the immediate financial impact has to some extent been offset by the strength of primary market rates, several CEOs feel that the long-term implications of higher retentions and lower peak-zone exposures may require something of a culture shift among many underwriters.

Distribution

The need to offset more volatile exposures by diversifying risk is adding to the impetus for London Market insurers to develop their business beyond the traditional distribution channels. This includes targeting more commoditised business in areas such as small- and medium-sized enterprise (SME) cover or incorporation into the admitted insurance market in the US.

However, the lower margins on commodity business will demand considerable cost control and process efficiency to ensure it is

‘ In order to achieve comparable underwriting performance to 2005, the biggest challenge is the availability and affordability of reinsurance.’ London Insurance Market CEO

01


profitable, especially if motor and casualty rates continue to soften. Insurers that have been used to the distribution and support functions of the London Market also face the challenge of developing marketing, automated pricing, transactional and customer relationship functions.

London will remain the core focus of survey participants’ business. Indeed, there was a sense that the Market’s viability and international reputation are, if anything, strengthening. CEOs praised the unique concentration of talent and expertise of a Market that brings together some 40,000 people. Several also stressed the enduring benefits of London’s sophisticated syndicated placement, in which brokers are adept at taking a risk, working out where the market lies and building business around it. ‘No market in the world can match that ability to place even the most complex risks so quickly’, said a CEO.

Process reform

However, there is evidence of some tension between brokers and insurers amid what several insurance CEOs believe are uncompetitive costs and service standards. The gap in the speed of claims settlement between London and other leading international insurance centres was noted as a particular challenge to London’s ability to attract business.

Several participants are keen to take on more of the service functions currently undertaken by brokers, leaving the latter to concentrate on their core competencies of market making, consultancy and advocacy. This may provide a further catalyst for the development of an itemised, fee-based structure of broker charges. It may in turn lead to a more disaggregated market in which particular aspects of the value chain are provided by dedicated specialists.

Moving forward

The challenges highlighted by the CEOs echo some of the wider issues we have seen emerging over the five years of our London Insurance Market surveys. This period has seen considerable development and progress since the wake-up call of 9/11.

London Market insurers have made great strides in enhancing the monitoring of their risk aggregations and establishing more rigorous underwriting limits, controls and review procedures. Yet, our latest survey once again raises questions about how effectively these safeguards are applied within many organisations. Moreover, while aggregations need to be measured and managed centrally, underwriting still tends to be conducted within distinct silos. Boards need greater



‘ The London Insurance Market is in the best shape it’s been in for some years. Last year, Market participants had their credit ratings reaffirmed quicker than virtually any other affected company or area.’London Insurance Market CEO

assurance that their business is not running too much risk, or indeed too little risk, and that the underlying control environment is functioning effectively. They also need to be confident that the companies’ defined corporate risk appetite is embedded into the day-to-day underwriting operations.

The understanding of risk exposures continues to develop. Yet, this remains an inexact science. Relevant data is not always available or captured at source. While catastrophe models are an integral part of underwriting in some classes such as property catastrophe, others such as offshore energy are still at an early stage in incorporating them into the decision-making framework. Above all, actual events continue to confound the expectations of even the most sophisticated models and extensive RDS analysis. Insurers are working on enhancing their supply of data and understanding of the correlations

of risks they face, while always being mindful of the relative limitations of their analysis and its implications.

There is now a much more informed and systematic basis for underwriting decisions, including the greater use of technical pricing and the more granular return on equity measures. Yet, in some organisations few underwriters have seen the corporate business plan. Few participants provide guidance on ‘walk away’ premium rates or the extent that underwriters can deviate from the technical price. Although respondents have said that they are prepared to take decisive action to limit the impact of a cycle downturn, the absence of adequate pricing control and monitoring could lead to a damaging disconnect between intention and execution.

In summary, while there is optimism for 2006, CEOs and their organisations are not standing still.

01



About the survey

The PricewaterhouseCoopers annual

London Insurance Market survey

examines the strategic and operational

drivers that will shape the future

direction and performance of the Market.

This year’s survey explored the

nature and implications of key

developments in underwriting,

including evolving approaches to

pricing, aggregation management,

controls and distribution. It also

examined the advances made in the

claims arena, a critical differentiator

in an increasingly competitive global

insurance marketplace.

The research is based on in-depth

questionnaires and face-to-face

interviews with executives from

Lloyd’s and Company Market

businesses, representing nearly

55% of Lloyd’s capacity and

combined estimated gross written

premium (GWP) of over £10 billion

in 2006. As before, the respondents

were selected to reflect a broad

spectrum of entity sizes, product

classes, independent businesses

and subsidiary organisations.

Our thanks go to all the organisations

and executives who kindly gave their

time to the survey and made this

report possible.

Please note that figure totals do not always add up to 100 because of rounding, or because respondents could choose more than one answer.


‘ There’s always room for improvement, but London is further advanced than most other major markets.’London Insurance Market CEO

Executive summary


Underwriting, distribution and aggregation management

Respondents’ confidence is tempered by concerns over the price and availability of reinsurance. The survey also raises questions about whether the supply of placing and management information is good enough to provide a fully effective basis for decision-making, and whether controls are enforced rigorously enough to provide assurance for company boards.

London Market insurers are facing an increasingly volatile risk equation in the wake of the growing frequency and severity of natural catastrophes. In response, participants have cut line sizes in peak catastrophe zones, recalibrated model assumptions and tightened up the monitoring and management of their aggregated exposures.

Having modelled this year’s exposures against a Hurricane Katrina-type event, most of those we interviewed appeared reasonably confident that the potential financial impact of a repeat event would be far less severe than last year. Yet, there is still a strong seam of doubt. Particular concerns centred on the quality of the underlying data, potential leakages in the capture of exposures, the lack of consistency between different classes of business and

the use of models that primarily

rely on relatively limited past

experience as a guide to the future.

Reinsurance crunch

The potential earnings volatility has

been heightened by the rapidly rising

prices and pressure on reinsurance

capacity, especially retrocessional

cover. One seasoned buyer

described this as the worst period

he had ever known. All respondents

feel that value for money from their

reinsurance programmes has

deteriorated in the face of what

more than 80% believe is a decline

in security, availability and flexibility

of cover. Nearly 60% feel that the

effectiveness of their programme

has decreased. Particular concerns

centred on the frequent insistence

on higher first layers of catastrophe

protection, ‘one shot’ cover,

aggregate windstorm limits and

other restrictive terms and

conditions that could make a

series of mid-level loss events

actually more financially damaging

than a single large loss.

Respondents are using ART

instruments to help make up for

some of the shortfall, though the

value of cover held is still small

in relation to the reinsurance

protections as a whole. Some

insurers have also tapped into the

extra reinsurance capacity opening

up in Bermuda, though there was

some concern about the business

models and short-term nature of

some of the new vehicles.

‘ We need to iron out the volatility and deliver more consistent returns.’Survey respondent

02


The primary response to the reinsurance crunch has therefore been a significant rise in retentions. The resulting reduction in the margin for error is clearly having a marked impact on underwriting strategies, including the need for lower line sizes, more precise control of exposures and greater risk/earnings diversification.

Rating outlook

The change in the risk equation can also be seen in a sharp rise in property and offshore energy premium rates, especially within peak catastrophe regions. Participants expect this hardening to persist until at least 2008. However, they anticipate that the trajectory of casualty, motor and aviation rates will be mainly downwards over this period. This could have a particular impact on insurers seeking to broaden their sources of earnings and to offset their volatile property catastrophe and offshore energy risks with more predictable non-cat business.

Our survey revealed that the use of technical pricing continues to increase. However, take-up is still far from universal, with technical pricing having been used in relation to around two-thirds of direct business in 2005. The response to changes in terms and conditions is still primarily a matter for underwriting judgement rather than quantitative analysis. Although precise quantitative analysis can be difficult, some participants are looking to apply greater consistency to the evaluation of and pricing for changes in terms and conditions.

Controls

The urgency of considerations about rating adequacy will clearly intensify if and when rates begin to soften. Around 20% of respondents have already implemented, and 70% are developing, pricing tools to help them prepare for a cycle downturn. All claim they would drop certain lines of business and reduce their underwriting headcount. However, integration of pricing mechanisms into underwriting controls is often limited. Less than 20% of respondents include guidelines on the permitted extent of deviation from the technical price and less than 30% document their pricing methodology within their underwriting guidelines.

More generally, the findings of our survey called into question the relevance and application of the underwriting guidelines within many organisations. In particular, less than two-fifths of respondents are confident that their guidelines are any more than partially integrated into their underwriting systems. Less than two-thirds incorporate maximum peak-zone aggregations into their authority limits. As the limited extent of integration of pricing into underwriting guidelines attests, the intentions of the centre may be disconnected from execution on the ground. It may also be difficult for boards to be confident that the controls are effective when guidelines may have material gaps and are not integrated into underwriting systems.

Executive summary Continued

02


Management information

Insurers’ ability to deal with a volatile and fast moving risk and commercial environment clearly depends on effective management information (MI). Over 50% are quite satisfied and less than 10% very satisfied with the quality and clarity of information, the reliability of the underlying data and their ability to use their MI to make key decisions.

Attracting business

The pressure of competition from other global centres and the desire for greater risk/earnings diversification have heightened the focus on distribution. London Market brokers, the major ones in particular, remain the primary and most prized source of business for participants. All respondents felt that their reputation in certain lines of business is one of the main reasons why they would be selected by a particular broker. More than 80% also felt that the strength of the relationship with the brokers would also affect the choice of insurer. However, only around one in five respondents currently collect information on either their broker relationships or their reputation in particular lines of business. More development may therefore be necessary in areas such as satisfaction surveys and the recording of broker feedback.

Barely a third of respondents measure the performance of their claims function and less than a third monitor the quality of their insurance accounting/back office processes. These factors are likely to become more important at a time when a number of leading brokers are moving towards the quantitative performance measurement of insurers’ services to help them select underwriters and demonstrate value to their clients.

Many participants believe that businesses within the London Market need to reduce costs and enhance efficiency to sustain their competitive position. Key developments include peer-to-peer (P2P) trading, which could help to eliminate some of the current delays and paperwork in placement and processing. Most respondents believe that there will be strong growth in P2P trading, though most expect that a full service electronic marketplace may take at least three years to become a reality.

It was also felt that the contract certainty initiative could help to speed up placement, reduce some of the litigation arising from wordings disputes and, more generally, enhance the reputation of the Market. Our survey revealed that participants consider that they are making strong progress towards achieving contract certainty and expect to meet the 85% compliance deadline.

‘ Reinsurance is more of a spot market than it has ever been.’Survey respondent


Portfolio development

Many participants are seeking to

develop new distribution channels.

This includes augmenting their

specialised London underwriting with

inroads into more commoditised

areas of business such as SME cover

or aspects of the admitted insurance

market in the US. Diversification into

more predictable areas of risk is seen

as especially important in seeking to

counterbalance the potential volatility

of property catastrophe and offshore

energy portfolios.

However, moving out from under the

umbrella of distribution, outsourced

bureaux and other aspects of the

supporting infrastructure of the

London Insurance Market creates

its own challenges. Companies

need to develop far more extensive

direct transactional and customer

relationship capabilities, while

grappling with the more exacting

cost, margin and service demands

of commoditised market segments.

Claims

The quality and efficiency of claims handling are benefiting from greater investment. Yet the survey questions whether controls, enforcement and review are broad or rigorous enough.

Improving claims service and claims

cost management has slipped from

fourth in 2005 to twelfth in the 2006

survey’s list of CEOs’ priorities.

At first glance this is perhaps

surprising, given both the quantum of

claims faced by the Market and the

growing importance of claims service and speed of settlement as key differentiators in an increasingly competitive global insurance marketplace. In particular, many participants highlighted the gap between average claims settlement times in London and Bermuda. London Market insurers have made significant efforts to enhance service levels, improve process efficiency and reduce legal expenditure. Nonetheless, the need to make further improvements is likely to grow as companies seek to develop their business in more commoditised high-volume markets.

The internal cost of claims handling accounts for 2.5% of gross claims costs on average. Legal expenses and claims adjusting costs are each more than 6% of gross claims costs on average. Against this background, many participants are looking to reduce such professional fees by streamlining their panels and taking more work in-house. While this may add to their fixed costs, many believe it gives them better control over claims settlement speed and litigation.

The quality of claims broking is seen as crucial in a subscription market. Yet, more respondents believe that claims broking has deteriorated rather than improved over the past three years. Participants would in particular like faster updating of case reserves and identification of redundant reserves on bureaux systems. A particular concern was the ever-growing legacy of claims from business in run-off.

‘Legacy issues are holding us back.’

Survey respondent


02


The growing use of documented claims guidelines is helping to enforce greater consistency and control. Many respondents believe that more systematic procedures could help to maximise reinsurance recoveries and speed up the closure of redundant claims. However, few include such key steps as the identification of subrogation and salvage opportunities, and their subsequent collection, in their guidelines.

Similarly, while all respondents apply authority limits for settlement, controls in other key areas including costs appear to be patchy. While around 15% of open claims files are subject to peer review, less than half of respondents check cost control, proposed levels of claims settlement and adherence to guidelines.

The move to electronic claims files (ECF) could help to facilitate significant improvements including faster communication and settlement, as well as more effective review of overseas and outsourced claims. As a consequence, almost all respondents have investigated the use of ECFs.

Most respondents are quite satisfied with their claims outsourcing arrangements, though none are very satisfied. Barely a quarter rate the transparency of performance measurement criteria under contract terms as important.

This is surprising given the fact that respondents judged poor MI and poor performance against service level agreement criteria as the two greatest sources of dissatisfaction with their delegated claims authorities.

High quality and timely MI is critical in driving improvement. Around two-thirds of respondents have invested in either significant or extensive improvements in their claims key performance indicator’s (KPIs) over the past three years. Around 50% have sought to enhance their claims MI suite. However, less than half are satisfied with their claims metrics and less than 40% satisfied with their claims MI suite. It is telling that less than half of respondents measure speed of claims settlement or report this to the board, even though they recognise that this is the most important criterion by which brokers judge claims performance.

It was nonetheless encouraging to note from our survey that claims teams are now receiving greater appreciation and reward than our previous surveys would suggest. More than three-quarters of respondents now recognise that it is very important that they have a high quality claims team. As a consequence, around a quarter of claims personnel’s pay is now variable and linked at least in part to their companies’ overall performance.



02

Conclusion

As our survey underlines, London Market insurers have continued to evolve to adapt to the latest challenges facing the global insurance market. In particular, they are developing:

Optimal portfolio management: Developing new distribution channels and products and the appropriate infrastructure to support these lines of business, while not alienating existing broker relationships, will be a delicate balancing act;

Effective cycle management: Managing the reduction in business volumes will be the acid test, but managing stakeholder expectations at the same time will also require considerable effort;

Robust controls: A fine balance will be required between exerting the right level of control and not stifling the judgement and opportunism of underwriters or the case strategy options of the claims team;

•

•

•

Timely and high quality MI: This is particularly important in relation to aggregations of exposure, premium rating adequacy and financial performance, and to facilitating marginal pricing. From a claims perspective, the key is to be able to measure performance on a balanced scorecard basis;

Risk appetite and capital management: It is a key business imperative that these be embedded throughout the organisation in order to encourage the right actions and behaviours; and

Faster claims settlement: Lead insurers have a key role to play and the availability of enabling technology such as ECFs and portals provides a real catalyst for change.

•

•

•


‘ Higher prices and further reductions in risk mean that the return on equity may still be attractive despite another severe wind storm season.’Survey respondent

Underwriting, distribution and aggregation managementOverview

Underwriting strategy


Pricing and control

Reinsurance crunch

Broker relationships

Developing distribution

Market of choice

Contract certainty

People


Overview

London Market insurers have sought to rein in their catastrophe exposures and diversify their risk and sources of earnings in the wake of the 2005 US hurricane losses. Will these measures be enough to sustain returns and maintain investor confidence?

Whether the 2005 US hurricane season was a freak or a portent for the future, the unexpected severity of the losses provided a big wake-up call for the London Market. The scale of the under-insurance by policyholders, storm surge and demand surge came as a particular surprise for many businesses.

In response, most participants cut line sizes in peak exposure zones, recalibrated catastrophe model assumptions and tightened up the monitoring and management of their aggregated exposures. Yet, could they be continuing to under-estimate the risks? The impact of the potential losses has been heightened by substantially harder reinsurance prices and reduced availability, especially of retrocessional capacity, and a resulting sharp rise in retentions. Equally, could the focus on natural catastrophes be taking their eye off other potentially calamitous perils in areas ranging from terrorism to epidemics?

The 2005 US hurricane losses do

need to be placed in perspective,

however. Several leading London

Market insurers posted record

half-year results prior to the 2005

storms. This remarkable

performance continued through

to the year-end for many of those

with limited property catastrophe

exposures. ‘The underlying book

of business outside property

catastrophe is performing brilliantly’,

said a respondent in our survey.

Many insurers are therefore seeking

to stabilise their risk/earnings

profile through a better balance

between volatile and attritional

risks. This includes developing new

distribution outlets in the US, UK

and Continental Europe. Such

business creates fresh challenges

including the need to develop

direct marketing, automated

pricing, transactional, claims and

customer service capabilities

geared to high-volume business.

These developments are taking

place against the background of

an increasingly competitive global

marketplace. In particular, the

Bermudan reinsurance market has

attracted a significant influx of

capital and capacity in 2006,

including investment from London

Market insurers themselves.

The London Market’s wealth of

expertise in specialist insurance

continues nonetheless to be highly

03

‘ One common criticism of the London Insurance Market is that “it is always fighting the last war”.’Survey respondent


prized. However, as a respondent

said, ‘we will lose business unless we

improve efficiency and reduce our

cost base’. The competitive impetus

for greater efficiency is likely to be

heightened by the growing moves

towards the quantitative performance

measurement of insurers by brokers.

Key indicators will focus on aspects

such as contract certainty, policy

administration and claims handling.

Ultimately, the London Market’s

competitive position depends on its

ability to meet the ever-more exacting

expectations of its capital providers,

both in the level and speed of returns.

The target return on equity for

respondents is typically more than 15%

over the five-year cycle (see Figure 2).

‘We’ve said that through the cycle we

want to make 10% return on equity in

excess of the risk-free rate. You can’t

do that if you’re only making two points

in a bad year’, said a respondent.

‘Certainly we’ve just had the worst

catastrophe year ever, but we’ve got to

get smarter.’ The findings of our survey

offer interesting insights into how

London Market insurers are seeking

to ‘get smarter’ in the face of these

new and evolving business dynamics.

Underwriting strategy

‘The risk equation has changed as we face what looks set to be a higher frequency and severity of catastrophe losses’, said a respondent in our survey. One clear result of this new equation is a sharp rise in property and offshore energy rates, especially within the wind-affected zones of Florida and the Gulf of Mexico. As Figure 3 highlights, respondents anticipate that the hardening of direct property and offshore energy premiums is unlikely to abate until at least 2008. The rate rises in the capacity-constrained inwards and retrocessional reinsurance markets are expected to be even more marked.

Yet, as Figure 3 also highlights, the direction of rates is nowhere near as uniform as would have been expected from past experience. The anticipated trajectory of casualty, motor and aviation rates is mainly downwards. These trends suggest that if insurers are to be able to continue to identify and assess profitable risks they will need to become more sophisticated in the wake of the wider application of


Figure 2: Please specify your 2005 actual and profitability targets for each of the following periods:

Return On Equity (ROE) Net Combined Ratio (NCR)

2005 actual 9.6% 107.5%

2005 target 21.9% 88.2 %

2006 target 16.6% 90.6 %

2007 target 16.2% 89.9 %

5 year target 15.6% 92.5%

‘15 years ago, an insurance profit

that translated into a 7% return on equity was seen as a stellar year. Now the long-term expectation is more than 10% as

your base line.’Survey respondent

Underwriting, distribution and aggregation management Continued

03


technical pricing. The bifurcation in rates may also pose a challenge for insurers seeking to broaden their earnings and offset their volatile property catastrophe risks with more predictable attritional business such as commercial motor.

Managing volatility

London Market insurers have taken a number of steps to adapt to the more hostile and uncertain catastrophe risk environment. These include adjusting their risk appetites, enhancing MI, amending their underwriting guidelines and tightening up their monitoring of peak-zone exposures (see Figure 4

overleaf). While much of this work had been ongoing, the 2005 losses ‘shook out any complacency and added a degree of urgency and emphasis to the process’, said a respondent.

The key impact on underwriting strategy for property classes has been a reduction in line sizes and, in some cases, sharp increase in attachment points in the most vulnerable wind and earthquake-affected regions. Nonetheless, property as a whole still remains the largest class in 2006 in terms of GWP. Direct and primary business also outweighs reinsurance writings. ‘We have


Figure 3: If the market premium rating is normalised to 100 for the 2005 underwriting year, at what level do you expect the market premium rating to be for the 2006, 2007 and 2008 underwriting years?

Direct and primary market

Property %

Casualty %

Marine %

Energy %

Aviation %

Motor %

2006 115.1 95.2 105.4 148.2 93.5 99.3

2007 120.1 94.1 103.1 141.3 91.4 99.3

2008 113.6 93.3 99.0 120.0 92.5 96.7

Inwards reinsurance market

Property %

Casualty %

Marine %

Energy %

Aviation %

Motor %

2006 127.4 99.4 126.4 165.0 100.4 100.0

2007 132.6 95.2 123.4 153.8 98.4 99.0

2008 132.0 92.5 115.0 140.0 96.3 97.5

Retrocessional reinsurance market

Property %

Casualty %

Marine %

Energy %

Aviation %

Motor %

2006 163.3 102.7 140.0 168.3 97.5 100.0

2007 156.7 100.0 130.0 155.0 95.0 97.5

2008 146.7 98.3 125.0 148.3 95.0 97.5


limited our reinsurance portfolio as any more would add too much volatility to our results’, said a respondent.

The under-estimation of the 2005 US hurricane losses (see Figure 5) has also spurred a recalibration of catastrophe models and the development of tougher RDS. Although the main catastrophe modelling firms have been readjusting parameters in their latest releases, half of respondents had gone further by adjusting their assumptions and outputs for both modelled and non-modelled perils by the time of our survey. For example, one participant modelled its 1/1 renewals on the basis of a possibility of loss of between 70% and 80% above the 2005 model parameters. Half had also changed the allowance for building codes and developed in-house assumptions for potential

demand surge, and more than 40% had strengthened data quality requirements and the allowance for under-insurance. Developments in the pipeline include the use of more than one model and the formulation of in-house climate change assumptions. Around two-thirds of respondents are also seeking to assure the markets, including regulators and credit rating agencies, by increasing the volume of disclosure about catastrophe risks.

Many of those we interviewed were confident that these developments would help to ease the risk of surprise losses in 2006. Most had run the 2005 US hurricane season through their newly adjusted models to judge how it would affect their current portfolio. ‘We’ve seen the initial output and it doesn’t cause us any alarm’, said a respondent. Yet, the efficacy of these improvements has yet to be battle tested.


03

Referral process

Peer reviews

Aggregation monitoring by peak exposure zone


Reporting to rating agencies

Other

Risk appetite policy

Underwriting guidelines

Underwriting authorities

14%

14%

79%

86%

7%

0%

7%

50%

64%

0 100%


Figure 4: What areas do you expect to amend/enhance within your underwriting strategy around catastrophe risks in 2006?


Main model output

There are particular concerns about the consequences of over-reliance on ‘black box’ models, especially if there are no other metrics to balance them against or the application of underwriting judgement to provide a sense check to them. A number of issues might affect the reliability of the model results, including the quality of the underlying data, potential leakages in the capture of exposures, the lack of consistency in approach between different classes of business and the use of models that primarily rely on relatively limited past experience as a guide to the future. ‘Insurers should place the model outputs in perspective and consider their total aggregations to a specific event’, said a participant.

Related concerns centred on the possibility of ‘model shopping’, given that the main proprietary models have historically yielded markedly differing results. Similarly some thought that too much focus on the probability rather than the quantum of loss might make genuine threats appear remote. ‘A one in 250 year loss may be judged by the underwriter as highly unlikely to happen in his or her lifetime and therefore a risk worth taking’, said a participant. Others countered that basing exposure analysis on the severity rather than the likelihood of certain events may be subjective and overly cautious. Either way, talk of a possible $100 billion US hurricane loss is now common.

0 100%

N/A

Quality of catastrophe models

Allowance for perils not modelled by catastrophe models

Estimation of demand surge impact

Estimation of other amplification factors(e.g. political, claims adjustment)

Reporting and capture of catastrophe exposures (e.g. replacement value, construction type)

Encoding of catastrophe exposure details(e.g. replacement value, construction type)

Modelling assumptions by user/underwriter (e.g. secondary perils)

Capture of contractual terms and inuring reinsurance

Recoverability of reinsurance (i.e. actual vs expected)

29%

14%

21%

36%

14%

21%

36%

21%

7%

14%

14%

14%

21%

14%

14%

14%

14%

14%

Not at all important Not very important Neither/Nor Quite important Most important

14%

14% 14%

14% 14% 21%

7% 7%

7%

29%

7% 43% 21%

50%7% 7%

7%

7%

7%

21% 14%

21%

29%

21%21%

14%7%36%

57% 14% 7%


Figure 5: What were the main reasons, if any, for the difference in the actual versus modelled results for the 2005 US hurricane losses?


Wider focus

Could the focus on natural catastrophes be diverting underwriters from equally serious threats? Considerable time and effort has clearly been invested in mapping and limiting the exposure to another Katrina-type event. Yet, half or less of respondents plan to produce analysis of their susceptibility to other major events, such as avian flu, a corporate scandal or a stock market crash. Over 80% do, however, model the potential losses arising from terrorism or flood. ‘These are events that have happened in recent years and will happen again’, said a respondent. ‘New Orleans under water is one thing; if it happened in Manhattan it could wipe out our industry’, said another.

The evolution of the Market in the face of this new risk equation is characterised by what a participant described as ‘more of a planning

mentality’. Business plans are

updated quarterly on average, though

some are reviewed and modified

every month. Respondents now set

their risk appetite with reference to

a wider, more transparent and readily

understandable series of measures

than would have been common in

the past (see Figure 6). Furthermore,

risk appetite is considered as a sub-

class of business level by more than

one-third of respondents. A further

third assess this in relation to

each class.

One participant believes that there is

still a crude outlook in some sections

of the London Market that ‘wants as

much capital as you can get to write

more business, rather than fine tuning

and optimising the use of capital’.

It would appear, however, that capital

allocation and return criteria have

become more sophisticated and risk

sensitive since we began our annual


03

Premium volume

Profitability

Financial strength rating

Probability of ruin

Probability of loss of surplus

Other

No risk appetite definition

Total value at risk/PML

MPL

RDS/catastrophe scenarios

0%

0%

50%

43%

14%

57%

36%

100%

57%

79%

0 100%


Figure 6: Which of the following reference points, if any, do you consider in your definition of risk appetite?

‘The precision and effectiveness with

which capital is deployed are critical. Capital management is not a high enough

priority in the London Market.’

Survey respondent


survey in 2002. Return on equity is now the primary profitability target within around two-thirds of respondents. Only 20% use combined operating ratio as their key objective.

Translating the risk appetite into a required rate of return against allocated capital for individual business units is a particular challenge for all financial services businesses. Although bidding for capital is now a common feature of underwriting plans and projections within the London Market, one participant has gone further by assessing each portfolio business plan against the target RoE.

All business plans are subject to significant and frequent reviews and challenges by participants’ boards. Key areas include rating movements and levels of aggregation, especially of catastrophe-related exposures, along with new business development through expansion into new territories, distribution channels and classes of business.


Insurers’ ability to deal with a rapidly evolving risk and commercial environment clearly depends on effective management information. Improving the timeliness and reliability of MI was a particular priority for the CEOs we interviewed as part of the survey. At least 60% of respondents

benchmark their loss ratios, large loss estimates and return on capital against their peers (see Figure 7 overleaf). More than 60% monitor their profitability at broker, sub-class and business segment level (see Figure 8 overleaf).

Although most respondents are quite satisfied with the quality and clarity of information, the reliability of the underlying data and their ability to use their MI to make key decisions, less than 10% are very satisfied in this regard (see Figure 9 overleaf). Only 15% are very satisfied with the timeliness and frequency of MI production, with the availability of actuarial and reinsurance recovery estimates seen as the greatest barriers to the faster production of MI (see Figure 10 overleaf).

Real-time measurement of aggregations is seen by some as essential in moving from a reactive to a proactive approach to tactical and strategic decision-making. However, the complexity of modelling systems and associated data collection means that analysis can take several weeks and may therefore be largely out of date by the time it is received and reviewed by business teams. One possible solution that is being pursued by a number of participants is to incorporate model and scenario outputs into more easily and rapidly updatable probable maximum loss (PML) evaluations. Although the calculations would

‘ Few companies know their risks well enough and are therefore going blind in many instances.’Survey respondent


not provide a precise set of analytics, they could offer enough data to provide an effective near real-time basis for decision-making.

In a related development, our survey suggests that the underwriting process is becoming more of a team

effort that draws on a range of specialist skills. For example, over the last three years the involvement of catastrophe modelling teams, actuaries and finance personnel has increased within more than 90%, nearly 80% and 50%, respectively, of those surveyed.


03

Underwriter level

Underwriting branch/office level

Broker level

Cedant level

Territory level

Other

Not monitored

Class level

Sub-class level

Business segment/trade

0%

0%

7%

14%

64%

36%

36%

64%

64%

93%

0 100%Source: PricewaterhouseCoopers 2006

Figure 8: At which of the following levels do you monitor your underwriting profitability?

Expenses

Investment return

Return on capital

Headcount

Other non-financial measures

No benchmarking is undertaken

Loss ratios

Combined operating ratios

Large loss estimates

7%

7%

36%

64%

50%

50%

64%

57%

71%


Figure 7: Which of the following do you benchmark against your peers?


Quality and clarity of information

Reliability of the underlying data

Timeliness of production

Frequency of production

Granularity of information

Quality of the discussion/feedback from Board members

Ability to use the MI to make key decisions

N/A

0%

0%

0%

0%

0%

8%

0%

Not at all satisfied Not very satisfied Neither/Nor Quite satisfied Very satisfied

0 100%

62% 8%

77% 8%

8%

69%

8%

8%

8%8%

15%

15%77%

46% 31%

31% 8%8%

54%

31%

8%

8%

8%

8%

15%

38%

38%


Figure 9: In terms of your management information, how satisfied are you with the following aspects?

0 100%

Availability of premium estimates (including pipelines)

Information from other subsidiaries

Information from parent company

Availability of actuarial estimates

Availability of reinsurance recovery estimates

Information from Lloyd’s/bureaux

Information from outsourcing companies

Quality of systems

Quality of data/reconciliation

Quality of finance staff/MI team

Quality of IT staff

43% 7%

14% 50%

50%

N/A

21% 7%

7% 7%

21% 7%

36% 21%

29% 0%

29% 0%

43% 0%

29% 0%

Most significant barrier Significant barrier Neither/Nor Small barrier Not a barrier at all

21%

21%

29%

29%36%7%

29%7%

7%

43% 7%

7% 7%

7%

7%

29%14%

14%

14%

36%

36% 14%

21%

14%21%29%7%

7%

29%7%

29% 21%

29% 43%


Figure 10: To what extent do the following potential barriers prevent you from producing your management information more quickly?


Pricing and control

The development of a more systematic approach to underwriting can equally be seen in the increasing use of rating models, though take-up is still far from universal. Our 2003 survey found that technical pricing was used to rate around 50% of direct business by volume. Our latest research revealed that rating models were used in relation to around two-thirds of direct business in 2005. Technical pricing will become even more standard practice as a result of new Lloyd’s underwriting standards that will require every syndicate to have a documented pricing policy and to capture the actual versus the technical price for every risk.

No single rating approach predominates for primary business. Around one-third of respondents use

exposure-based rates and one-third use experience-based rates. Rating adequacy is most commonly monitored at renewal and most consistently applied to property business (see Figure 11). It is noticeable that respondents tracked the departure from the technical rate in relation to less than half of new business written in 2005, though this may be a reflection of what was considered to be a hard market. This is borne out by the fact that the actual departure from the technical price was around 15% on average in 2005.

Rate movement monitoring is more widespread in the Market and is one part of a wider basis for decision-making that should ideally include a systematic assessment of the impact of revised terms and conditions. However, our survey indicates that the response to such changes is still


03

Property

79

9386

50 5043 43

86

57 57

29 29

71 71

21 21 21 21 21 21 21

14 14

7

Casualty Marine Energy Aviation Motor

%

0

20

40

60

80

100

Renewal New business Lapsed/declined No response


Figure 11: At what levels do you monitor premium rate adequacy?

‘Everyone’s talking a good game about

using rating models, but they’re a blunt

tool, especially if they fail to factor in terms

and conditions.’Survey respondent


primarily a matter for underwriting judgement. In a step towards a more quantitative approach, one respondent does seek to give such amendments a monetary value. Another assesses each risk against four analytical elements – original rate change, reinsurance rate change, exposure change and subjective change. However, it is important to recognise the limitations of rate movement monitoring as it only provides information on the direction of premium rates, and does not answer the ultimate questions of whether premium rates for a particular risk or portfolio are adequate or will meet the required return on capital.

The urgency of the considerations about rating adequacy will clearly intensify as rates in casualty, aviation and other classes begin to dip. Around 20% of respondents have already implemented pricing tools to help them prepare for a cycle downturn. A further 70% are developing them. Rating adequacy assessments also rank alongside renewal rate monitoring and peer reviews as respondents’ most important tools for managing a softening in the market (see Figure 12).

If the underwriting performance for the last downturn was repeated, the anticipated response to such a softening in rates could be quite

‘ The traditional cycle is now a thing of the past. Computing has helped to make the Market more rational.’Survey respondent

Renewal rate movement monitoring

N/A

Premium rate adequacy monitoring

Peer review

Underwriting guidelines

Pricing guidelines

Performance benchmarking

Validation of portfolio premium rates

New business/declinature ratio monitoring

Actuarial type reviews on portfolio profitability

Other

0%

0%

0%

0%

0%

14%

0%

0%

79%

No reliance Little reliance Some reliance Significant reliance Most reliance

0 100%

0%29%7% 64%

29%7% 43%

36%7% 43%

29%14% 29%

50%21% 7%

15%8% 15% 23%

29%14% 21% 14%

21%7% 29% 7%

54%15% 23%

7% 14%

21%

14%

29%

21%

38%

7%

36%

8%


Figure 12: To what extent will the following controls be used by you to manage a cycle downturn?



03

dramatic. All the respondents said they would withdraw from at least some classes of business, with more than one-third expecting to exit from more than 10%, and around 15% planning to drop at least 25% of business lines. All would also cut their underwriting headcount, with nearly 30% anticipating that between 11% and 25% of their underwriting personnel would need to be released.

How effectively rating adequacy will be enforced in practice is another question. As Figure 13 highlights, less than 20% of respondents include guidance on the extent of deviation from the technical price, and less than 30% document their pricing methodology within their underwriting guidelines. Similarly, less than 30% of underwriting audits regularly cover technical pricing or adherence to pricing guidelines.

Capacity

Underwriting ethos

Limits

Target returns

Risk appetite

Purchasing of outwards reinsurance

Risk aggregation guidelines

Risk selection criteria

Minimum data requirements

Delegated underwriting authorities

Policy wording guidelines

Pricing methodology

Premium rates/adjustments

Pricing guidelines (deviation from technical price)

Achievement of contract certainty

Underwriting file documentation

Other

No underwriting guidelines are in use

86%

93%

43%

36%

79%

71%

86%

43%

43%

93%

14%

29%

43%

14%

71%

36%

0%

7%

0 100%


Figure 13: Which of the following, if any, are included in your underwriting guidelines?


Net limits

Gross individal risk PML

Net individual risk PML

Peak-zone maximum aggregation

Other

No underwriting authorities are in use

Gross premiums

Net premiums

Gross limits

0%

7%

64%

7%

21%

29%

100%

0%

36%

0 100%


Figure 14: What metrics are used to define the underwriter’s individual authority limits?

More generally, the findings of our survey called into question the relevance and application of the underwriting guidelines within many organisations. In particular, less than two-fifths of respondents are confident that their guidelines are any more than partially integrated into their underwriting systems. It is also more than three years on average since the manuals/guidelines were updated. In one case it was 12 years.

That said, more than 90% of respondents include authority limits for their underwriters and those with delegated underwriting authority within their guidelines. However, in the light of recent events, it is perhaps surprising that less than two-thirds incorporate

maximum peak-zone aggregations into their authority limits (see Figure 14). It is also noticeable that while at least 80% undertake peer reviews or internal audits to ensure compliance, barely 20% subject their authority limits to external review. This second pair of eyes could not only help to bolster adherence to the guidelines, but also ensure that the controls are fit for purpose.

Around three-quarters of direct and inwards reinsurance risks/underwriting files (by GWP) are reviewed by the underwriters’ peers. Independent audit, however, is far less widespread, covering barely 20% of direct risks and less than 10% of inwards reinsurance business. As would be expected,



03

adherence to authority limits is a key focus of these audits (see Figure 15). As mentioned earlier, the auditing of price-related factors is still relatively rare. Even fewer carry out quantitative analysis of underwriting leakage. Instead, as Figure 16 indicates, monitoring of the profitability, volume and mix of business are the most common ways employed by management to keep track on underwriting and pricing.

Overall, our survey found that the processes, controls and basis for underwriting decision-making are evolving rapidly in the face of an

increasingly complex and uncertain risk environment. Yet, most respondents would accept that their operations would benefit from higher quality and timelier information, better cascaded top-level direction and more effective organisation-wide co-ordination. As the limited extent of integration of pricing into underwriting guidelines attests, the intentions of the centre may be disconnected from execution on the ground. It may also be difficult for boards to be confident that the controls are effective when guidelines may have material gaps and are not integrated into underwriting systems.

Adherence to underwriting authorities

N/A

Adherence to underwriting guidelines

Adherence to pricing guidelines

Premium rate movement analysis

Technical pricing

Premium rate adequacy analysis

Underwriting file documentation

Aggregation/CAT modelling analysis

Quantitative underwriting leakage

0%

7%

14%

7%

7%

14%

7%

7%

31%

Not at all Some classes Many classes Regularly for most classes Regularly for all classes

0 100%

21% 79%

21% 57%

7%14% 29%

29%14% 36%

21%21% 7%

7%

21%

36%21% 7%

43%21%

23%23%

21%

21%7% 36%

8%

14%

29%

14%

21%

21%

7%

29%

15%


Figure 15: To what extent do your underwriting audits cover the following areas?


Reinsurance crunch

One of the key factors underlying the new risk equation is the pressure on reinsurance capacity and resulting rise in premium rates, especially within the retrocessional market. In broad terms, prices for retro coverage have doubled while capacity has shrunk by one-third since July 2005. One seasoned reinsurance buyer described this as the worst period he had known.

As Figure 17 overleaf highlights, all respondents feel that value for money from their outwards reinsurance protections has deteriorated in the face of what more than 80% believe is a decline in security, availability and flexibility of cover. Nearly 60% feel that the effectiveness of their programme has decreased (see Figure 18 overleaf). Particular concerns centred on what in many cases have been sellers’ insistence on higher first layers of catastrophe

‘ There is clearly a capacity crunch at the peak exposures and it’s going to get worse.’Survey respondent

Performance presentations to executives

Independent portfolio reviews

Actuarial pricing

Underwriting forums

Portfolio pricing reviews

Underwriting/pricing committees for high risk accounts

Monitoring of volumes and mix of business

Monitoring of profitability

Monitoring of declined business

Monitoring of actual prices vs. technical prices

Comparisons against competitors

7%

0%

7%

14%

7%

0%

7%

7%

7%

Not at all Few classes Many classes Regularly for most classes Regularly for all classes

0 100%

14% 0%

N/A

21% 0%

64%14%

29% 36%14%

14%

7%

14%21% 7%

36%14%

14%29%

14%

29%7%

7%

21% 7%

21% 7% 7%

21% 57%

21% 79%

14%29% 21%

21%21% 7%

14% 7%

50%

36%

29%

43%

14%

29%

29%

29%


Figure 16: To what extent are the following controls used for your underwriting and pricing?



03

protection, ‘one shot’ cover, aggregate windstorm limits and other restrictive terms and conditions which could make a series of mid-level loss events actually more financially damaging than a single large market loss.

It was generally felt that catastrophe cover is available if companies are prepared to pay, though in some classes rates appeared to have been rising by the day in the immediate run-up to the 1 July 2006 renewals. As a result, respondents have had little choice but to increase retentions. They expect that 18% of their GWP in 2006 will be ceded to third parties compared to 22% in our survey in 2004. ‘The cost of retro capital is more expensive than our own capital, so we might as well use our own’, said a participant.

Extra capacity has been opened up in Bermuda, especially through the emergence of mono-line side-car vehicles. However, the one loss and collateralisation terms that are often required conflict with the buying preferences cited in our survey. Several of the executives we interviewed expressed misgivings about the risk profiles of some of these entities. ‘It’s a volatile market and you do have to think twice’, said a respondent. Others were concerned that some of these new vehicles may not be around long enough to provide the desired continuity of cover and future payback from the prices currently being charged. ‘This is not the reinsurance “bank” we have become accustomed to’, said a participant.

Level of expertise/knowledge in-house

Regulatory/accounting aspects

Availability and security of hedge fund risk providers

Value for money

Cost compared to Alternative Risk Transfer

Security

Level of flexibility

Complexity of contracts

Availability of required cover

0%

0%

0%

100%

64%

43%

86%

93%

93%

0 100%


Figure 17: Where have your perceptions of the traditional reinsurance markets for risk transfer deteriorated in the last year in relation to the following factors?

‘If there is sufficient demand, some form of retro supply will

materialise. The price and terms are the real question’.

Survey respondent


Figure 19 sets out the proportions of the different types of reinsurance being placed in 2006. Interest in ART instruments is increasing (see Figure 20 overleaf), with over 60% believing that ART products are more competitively priced than their conventional counterparts. Of the half of respondents that have used ART, around 30% have deployed catastrophe bonds and insurance securitisation (see Figure 21 overleaf). Others had used credit and weather derivatives. However, one respondent raised concerns about ‘cat bonds being too closely defined’. He feels that the ‘capital markets need to offer broader cover

N/A

Effectiveness of programme

Strictness of terms & conditions

Availability of proportional reinsurance

Availability of non-proportional reinsurance

Availability of retrocessional reinsurance

Availability of non-traditional reinsurance

Availability of Industry Loss Warranty covers

Collateralisation requirements

Variety of available types of cover

7%

7%

14%

7%

14%

14%

14%

7%

7%

Decreased most Decreased slightly Neither/Nor Increased slightly Increased most

0 100%

50%7% 14%

7% 50% 21%

36%7%

7% 50%

36%50%

21%7% 36%

21% 14%

29%14%

21% 21% 7%

21%

14%

43%

36%

21%

50%

50%

43%


Figure 18: When purchasing primary reinsurance or retrocessional cover, please indicate by how much you think the following factors have increased or decreased since 2005 in each case:

‘My big fear is a series of medium severity events, as the nature of my reinsurance cover means these could affect my balance sheet more than one big hit’.Survey respondent

FacultativeProportional treatyNon-proportional treatyNon-traditional reinsurance

11%

34.2%53.7%

1.2%


Figure 19: What proportion by value of your outwards reinsurance in 2006 will be placed on each of the following bases?



03

Weather derivatives

Credit derivatives

Credit securitisation

Insurance securitisation

Non-catastrophe securitisation

Other

Not disclosed

Catastrophe bonds

Mortality bonds

Catastrophe swaps

29%

0%

0%

29%

0%

14%

14%

0%

0%

29%

0 100%


Figure 21: If applicable, what capital market risk transfer products have you used?

Yes, and increasingly doing so

Yes, about the same as last year

Yes, but less than before

No, but considering

No, not considering

0 100%

36%

0%

50%

0%

14%


Figure 20: Did you use, or are you considering using, the capital markets for risk transfer in 2006?

to be effective’. Another participant wondered why climatic and other catastrophe protection is still the primary focus of capital markets securitisation. ‘If the risk can be measured, it should be possible to securitise it’, he said.

While ART and new capacity may help to fill some of the breach, most insurers have little choice but to retain more risk. Underwriting on a ‘gross

equals net’ basis could have a profound impact on the risk profiles and line sizes that London Market insurers will be able to maintain, especially within the more volatile insurance classes. ‘Most Lloyd’s businesses have been reliant on retro. The withdrawal of retro will therefore change the shape of the Market’, said a respondent. Another participant questioned the impact of a reduction in line sizes on valued


client relationships. ‘We’ve written net lines in the past when we’ve had to, but we prefer not to because our clients want us to offer them the same level of cover as in the past’, he said.

As inwards and retrocessional reinsurance prices continue to rise over the next two years, the pressure on London Market insurers’ business models and underwriting strategies is likely to intensify. In the future, they may need to modify their risk profiles still further and/or change their reinsurance buying strategies and preferences in pursuit of more short-term arrangements and ART cover.

Broker relationships

London Market brokers, the major ones in particular, remain the primary and most prized source of business for participants. As Figure 22 indicates, more than three-quarters

of GWP is expected to be sourced from London Market brokers in 2006, largely unchanged from last year.

While evolving, the business relationship between broker and underwriter remains ‘symbiotic’, as one respondent described it. There was also recognition of the significant contribution of brokers in the operations of a syndicated market. ‘Commission rates in Bermuda are effectively lower than in London’, said a respondent. ‘The real value of this extra brokerage is the ability of the broker to work out where the market lies on a particular risk and choose a point to build that business around. In Bermuda it’s much more difficult to get that level of consensus.’

The main criteria for selecting a producing broker were seen as access to key geographical markets and to specific business segments. One of the brokers we interviewed was surprised that


Figure 22: What proportion of your gross written premiums is sourced from the following?

2005 (mean value)

2006 (mean value)

London Market brokers 76.4% 75.5%

Other brokers 5.7% 6%

Direct 1.3% 1%

Delegated underwriting authorities 16.6% 17.5%

Total 100% 100%



03

barely 20% rated slip accuracy or the likelihood of achieving contract certainty as influential. Monitoring of the size of the producing brokers or their market share was viewed as the most important criteria for broker performance evaluation (see Figure 23).

Asked why a broker would select them in turn, all respondents felt that their reputation in certain lines of business is influential. More than 80% also felt that the relationship with the broker would affect the broker’s choice of insurer. However, only around one in five respondents currently collect information on either their broker relationships or their reputation in particular lines of business (see Figure 24). More development may therefore be necessary in areas such as satisfaction surveys and the recording of broker feedback.

Barely one-third of respondents measure the performance of their claims function and less than one-third monitor the quality of their insurance accounting/back office processes. These factors are likely to become more important at a time when a number of leading brokers are moving towards the quantitative performance measurement of insurers’ services to help them select underwriters and demonstrate value to their clients. Many brokers are also looking to save money and improve efficiency by streamlining the number of insurers they place business with, and could therefore use the performance measures as part of their selection criteria. ‘The service KPIs are likely to be especially critical in choosing between insurers that do not have a strong relationship with the broker’, said a broker.

Extent of achievement of contract certainty

Existing relationship

Policy wording support

Claims support

Accuracy of slip production

Other

None of the above

Size of broker/broker’s market share

Overall level of service

Quality of risk information

0%

21%

14%

21%

7%

36%

57%

21%

29%

71%

0 100%


Figure 23: For which of the following factors, if any, do you maintain management information and monitor performance in relation to brokers?


Another significant development within the broking sector is likely to be greater segmentation of clients by size. One respondent questioned how much of the lower commission, smaller risks business would continue to be placed in London, especially if the costs remain unchanged. Another feels that such moves could provide a further spur for the faster and potentially more cost-effective electronic placement of routine risks.

Greater electronic placement and data transfer are clearly key priorities for both brokers and underwriters within the London Market. ‘It is inexplicable that we still have people queuing up at the box to place routine risks or sign straightforward endorsements’, said a broker. ‘In turn, this wastes time in the back office as people have to sit around waiting for the broker or underwriter to come back from the floor with the files they need to

Financial strength rating

Premium rate

Capital base

Commission rate

Level of service – underwriting

Level of service – transaction speed

Level of service – time to contract certainty

Level of service – willingness to accept ‘accommodation business’

Level of service – ‘reserved capacity‘ for specialist business

Level of service – claims

Level of service – insurance accounting/back office processing

Level of service – quality of systems

Underwriting reputation in certain lines of business

Brand name/reputation

Broker relationship with underwriting team

Other

None of the above

86%

79%

64%

79%

21%

7%

71%

0%

7%

36%

29%

0%

21%

36%

14%

0%

7%

0 100%


Figure 24: For which of the following factors which you think brokers consider as important in placing business with you, if any, do you maintain management information and monitor performance about your own organisation?


process.’ Once in the back office, there are often further delays and the potential for input error as data is re-entered manually before being passed on to the next stage in the chain.

Many participants believe that the developments being pioneered initially by the G6 group within the Lloyd’s Market, with support from the larger brokers, will help to accelerate the pace of process improvement. ‘The G6 has provided a wake up call for Lloyd’s and the Lloyd’s Market Association (LMA) that the pace of change was too slow’, said a respondent.

As Figure 25 reveals, most respondents believe that there will be strong growth in peer-to-peer (P2P) trading, though as Figure 26 highlights, most expect that a full service electronic marketplace may take at least three years to become a reality.

Some have reservations. ‘Electronic platforms can assist placement and follow placement, but may not be the best way to conduct the actual trade’, said a respondent. A broker argued that ‘while some straightforward business can easily be placed through P2P, more specialised


1 Year

2-3 years

3-5 years

5+ years

It will never happen

0 100%

7%

0%

29%

43%

21%


Figure 26: Within what timeframe, if at all, do you expect a full-placement P2P marketplace to become a reality?

Peer-to-peer trading (P2P)

Noresponse

Brokers via market platforms

Electronic direct trading

Non-electronic direct trading

Delegated underwriting authorities

0 100%

7%

0%

7% 0%

36% 7%

36% 0%

Strong decline Small decline No growth Small growth Strong growth

36% 57%

57% 7%

21%21%7% 7%

57% 36%

64%7% 29%


Figure 25: What level of growth do you expect to see between 2005 and 2010 in the following distribution methods?

03


primary risks may still require face-to-face meetings’. Another broker is concerned that ‘some of the smaller underwriters may resist changes they may feel would squeeze them out of certain areas of business’. The end result, he feels, may be a two-tiered market or even the creation of a de facto super league formed around the larger players.

A number of participants also believe that the process developments being pursued by the larger players will accelerate the move away from blanket commissions to itemised, service-based fees. ‘What we’re trying to do now through the efforts of G6 and others is to say “let’s make the process more seamless”, which means we as underwriters should take on some of the duties such as policy production’, said a participant. ‘This should then of course mean that the brokerage, the acquisition cost, should go down.’ Several participants believe that moving to a ‘menu’ of charges could in turn act as a catalyst for the disaggregation of the value chain. Brokers would then primarily focus on market making, consultancy and advocacy, while specialist service providers might emerge in areas such as contract wordings and claims handling.

Others have their doubts, especially as the move to a fee-based system has so far proved much slower than many had originally anticipated. ‘I haven’t

seen any great evidence of

re-engineering in the face of the

new financial realities’, said a

respondent. Any such breakdown

of charges clearly requires an

understanding of how much each

component costs and how much

value it adds to the end-user.

However, ‘brokers are not very

good at quantifying value, having

always worked on a commission

basis’, said a participant.

Demands for greater transparency

could provide a powerful impetus

for change. ‘Once we have greater

disclosure, we’re going to see

some interesting changes in the

marketplace’, said a respondent.

This includes more clarity over the

services the broker provides.

‘Menus’ of services being offered

by brokers could also become

more of a feature over the next

12 months.

Developing distribution

A number of London Market

insurers have, over time, set up

operations in Bermuda to write

predominantly property

catastrophe reinsurance. Many

of the larger companies are also

seeking to develop their network

of representative offices in the UK,

the US, Continental Europe and

Asia (see Figure 27 overleaf).

Clearly, many companies are keen

to access business that may not

come to London as a rule. ‘More

of the business we used to see is

now being placed locally in a

‘ P2P will happen because the brokers want it to happen.’Survey respondent



number of markets, so we need to get closer to the source, especially as rates soften’, said a respondent. One participant had gone further by seeking to market specialist products developed in London across all the group’s distribution platforms.

The development of new distribution outlets could help to counterbalance the uncertain and volatile property catastrophe risks with business that has a steadier and more predictable risk profile and earnings trajectory. ‘Investors, regulators and rating agencies do appear to favour the composite business model with its diversified books of business over the mono-line route’, said a respondent.

However, moving out from under the umbrella of distribution, outsourced bureaux and other supporting infrastructure of the London Market creates its own challenges. The hurdles

cited by respondents ranged from the development of insurance ledgers to direct marketing capabilities. Much of the business development is also focused on commoditised markets, where the need for differentiation and rigorous cost control is likely to be critical, especially when seeking to compete with larger and more established companies with greater economies of scale. They may also need to adapt some of their analytical processes, such as moving to the use of rating engines.

It is clear from our interviews that many participants have been able to carve out valuable niches. The precision of the underwriting developed in more bespoke areas of the business offers a clear advantage. However, developing new distribution outlets can be difficult, especially as access to the market is very different in each particular region.

‘London is a wonderful model for a syndicated

market. The placing is fantastic and

there is more capacity than in

any other market in the world.’

Survey respondent

US

Noresponse

Bermuda

Ireland

Europe

Asia

0 100%

9% 9%

0%

0%

9%

13%

Strong decline Small decline No growth Small growth Strong growth

64% 18%

38% 38%

64% 27%

67%

25% 50%25%

33%

13%


Figure 27: What level of growth do you expect to see between 2005 and 2010 in the following market places?

03


More generally, one broker

expressed doubts about the

expense of all this development,

especially for Lloyd’s underwriters.

‘While the blueprint for Lloyd’s was

originally a no-cost or at least low-

cost organisation, the companies

themselves have added to their

fixed cost base by developing

representative offices around the

world’, he said.

Market of choice

As Figure 28 highlights,

respondents see underwriting

expertise and the subscription

nature of the market as the

unparalleled strengths of the

London Market. Many also cited

the benefit of London’s

underwriting infrastructure.

Many believe that Bermuda is

now the pre-eminent centre for

property catastrophe reinsurance.

The attractions include access

to a lot of the high-value US

business not generally seen in

London. Figure 28 also highlights

the island’s perceived tax and

regulatory advantages, though a

respondent did insist that ‘tax is

not a valid business reason to set


Figure 28: Top reasons for writing business in each key territory:

London

Ireland Bermuda US EuropeLloyd’s Company

Underwriting expertise 3.53 3.36 1.33 0.8 1.67 2.0

Broker distribution network 2.85 3.18 2.0 0.8 2.83 3.83

Proximity to HQ 0 0 0 0.4 0.83 0.33

Underwriting infrastructure 1.69 1.91 0.5 0.1 0.67 0.33

Subscription market 2.15 1.45 0 0 0 0

Access to capital markets 0 0.27 0 0.4 0.67 0.17

Access to skilled staff 1.62 1.82 1.33 0.2 1.33 1.33

Access to local market/specialist risks 0.85 2.18 1.33 0 4.67 4.33

Access to other markets 0.15 0 0.33 0.5 0 0

Access to professional services 0.08 0.55 0 0.2 0.5 0

Regulatory environment 0 0.09 2.67 3.8 0 0

Acquisition cost 0 0.09 0.83 1.6 1.0 0.67

Capital flexibility 1.31 0 0.17 0.4 0 0

Operating expenses 0.31 0 0 0 0.17 0.67

Taxation 0 0 2.83 4.8 0 0

Other 0.46 0.09 0 0 0.17 0.17

Scores have been calculated whereby the most important issue scored 5, the second most important issue scored 4, etc.

‘ We will move capital into a place where it’s most efficient. We are less inclined to fix what’s wrong and more inclined to exploit the place that has the advantage over it.’Survey respondent



up in Bermuda, just a good end

result’. Several interviewees stressed

that the regulatory regime in the UK is

‘neutral’ rather than a competitive

impediment, especially now the

Financial Services Authority (FSA) is

seeking to speed up its authorisation

processes for wholesale operations.

However, some feel that taxation

levels in the UK may encourage

investors towards Bermuda at the

expense of London.

The cost and perceived inefficiencies of

operating in London are a continuing

cause for concern. ‘We might be at

the top of the London Market in an

area like claims, but so what if we’re

still way behind our international

competitors’, said a respondent.

‘We like London as you can get the

business underwritten in a day’, said

a broker. ‘Yet, the way business is

processed can be needlessly slow

and behind the times.’

Contract certainty

Achieving contract certainty is one of

the areas where progress has been

most rapid across the market. The

Market Reform Group defines

contract certainty as the complete

and final agreement of all terms

(including signed lines) between the

insured and insurers before inception.

In addition, ‘the full wording must be

agreed before any insurer formally

commits to the contract’ and ‘an

appropriate evidence of cover is to be

issued within 30 days of inception’.

The London Market is committed to

achieving 85% contract certainty by

the end of 2006.

Respondents reported that they have

already achieved 75% contract

certainty on average, and almost all

expect to exceed the 85% threshold

by the end of the year. Participants

pointed to a number of potential

hurdles in seeking to achieve

compliance, though few saw these

as being any more than slightly

problematic (see Figure 29).

More than 80% of respondents have

required additional recruitment and

made more use of model/standard

wordings to meet the extra demands

in relation to the origination of

contract wordings (see Figure 30).

The Market is looking to support the

latter through the development of a

wordings library. Most have also

incorporated the achievement of

contract certainty into their

underwriting guidelines.

While regulation has accelerated the

pace of development, it is widely

recognised within the Market that

contract certainty could help to enhance

the Market’s reputation and provide a

platform for further improvement. This

includes helping to reduce needless and

costly litigation arising from wordings

disputes. It was also felt that greater

standardisation of wordings and the

need to speed up agreement of terms

and conditions could provide further

impetus for electronic trading.

‘At least 90% of the wordings could be standardised, but

we need to get co-operation between

the brokers and underwriters to

make this possible.’Survey respondent

‘We’re not efficient enough, we’re not

automated enough, people are fed up of

dealing with our antiquated systems.’

Survey respondent

03


People

Access to skilled staff was seen

as one of the London Market’s

competitive advantages over its

international rivals. ‘You have this

unusual concentration of expertise in

London’, said a respondent. ‘It’s not

just underwriters, it’s actuaries, claims

people, finance people, wordings

people, cat modelling specialists

and all the rest.’ Indeed, the typical

70-strong underwriting department

of our respondents now includes

more than a dozen statisticians,

catastrophe modellers and pricing

actuaries (see Figure 31 overleaf).

Yet, despite employing around

40,000 people, London Market

businesses still struggle to recruit

and retain staff. Finance, IT and

wordings specialists were among

the types of staff cited as being in

shortest supply. ‘The London

Insurance Market is short of

talented people’, said a respondent.

‘I don’t think that as a Market we

N/A

Delegated authorities

Leader of subscription business

Follower of subscription business

Particular class of business

Brokers not complying with code of practice

9%

0%

18%

45%

36%

Most problematic Slightly problematic Neither/Nor Not very problematic Not problematic at all

0 100%

18% 45%

9% 45%36%

18% 18% 18%

18% 18%

9%

9%

27%18%

9%

9%

27%

9%

27%


Figure 29: In attempting to achieve contract certainty by inception date, please grade how the following factors have acted as an impediment to success:

More wordings origination by you (as opposed to brokers)

Increase in wordings origination/review resources

A shift of wordings origination resources to the front office to more directly support underwriters

More use of model/standard wordings

0 100%

82%

82%

82%

55%


Figure 30: In relation to policy wordings origination, which of the following are you observing?



are very good at attracting enough people from outside the incestuous pool from which we tend to recruit.’

While few actually cited a shortage of underwriters, their remuneration is clearly critical to the motivation and retention of frontline talent. Spiralling salary inflation and huge signing-on fees were just some of the symptoms of the competition for the best people. Around three-quarters of our respondents’ underwriters’ pay was fixed in 2005 and the remainder

variable. If 2006 proves to be a relatively profitable year, the fixed/variable division will move to 60:40 on average. If it turns out to be a poor year, the split will slip to 90:10. Variable remuneration for a particular underwriting year is paid out over two and a half years on average, though some respondents stretch it out over five. The main determining factors of bonuses are levels of underwriting profit and return on capital. Volume-based bonuses have all but disappeared.


Figure 31: What is the size of your underwriting department within your organisation, including underwriting support teams?

2005 2006

Underwriters 36 people 39 people

Assistant underwriters 20 people 22 people

Cat modellers 5 people 5 people

Pricing actuaries 3 people 4 people

Statisticians 4 people 4 people

Total 68 people 74 people

03


‘ Too much business is placed on the basis of insufficient information.’Survey respondent

Claims at a premium

Counting the cost

Enhancing claims processes

Outsourcing

Performance measurement

People


Claims is set to emerge as a key competitive differentiator as London Market insurers face more rigorous performance rating by brokers and companies seek to develop their business in more commoditised markets.

Over the five years of the London Insurance Market survey, we have charted a steady evolution of the claims function from what a respondent described as the ‘poor relation’ towards its current position as a critical benchmark for service, performance and reputation within an increasingly competitive marketplace.

Improving claims service and claims cost management has slipped from fourth on the CEOs’ agenda in 2006 to a far more modest 12th this year. This could reflect the increased focus on other priorities in 2006. It may also reflect significant operational progress made in recent years and a generally creditable performance of London Market claims teams in the wake of the 2004 and 2005 hurricane losses.

What about the routine claims, however? ‘While Lloyd’s businesses have always been good at the big claims, it’s the legacy backlog and cumulative inefficiencies over run of the mill claims that drags them down’, said a respondent. In particular, our survey revealed concerns about the gap in speed of

settlement that appears to

be opening up between London

and its US and Bermudan

competitors. ‘Bermuda thinks in

days, we think in weeks, months

and even years’, said a

respondent. The pressure for

improvements in service and cost

effectiveness is likely to heighten

as London Market insurers move

into more commoditised high

volume business.

Recent years have seen significant

investment in key areas of claims

service and settlement such as

process improvement, electronic

claims files and new workflow

management tools, as well as

sizeable levels of recruitment.

The last few years have also seen

the launch of Market-wide initiatives

designed to help improve service

levels and speed up settlement.

However, our survey reveals a

more mixed picture of the

attainment of these objectives.

Counting the cost

The average size of our respondents’

claims teams has risen from

12 to 20 since 2003, which would

suggest that improving service

is a priority. Around 35% of

claims personnel now have legal,

insurance or other professional

qualifications. The proportion

varies from company to company,

which may reflect the fact that

certain companies tend to follow

rather than lead business.

‘ The claims side in the subscription market can be quite clumsy. There are a lot of people in the chain. I think we need to simplify it as much as we can.’Survey respondent

04


Claims at a premium Continued

As Figure 32 highlights, claims functions tend to be structured around specialised aspects of the business, be this class of business, sub class or type of claim. There is a reasonably even split between claims functions that are independent from, and those that are embedded within, underwriting teams.

The internal cost of claims handling, accounts for 2.5% of gross claims costs on average. Legal expenses and claims adjusting costs are each more than 6% of gross claims costs on average. Concentration in

particular liability lines such as Directors & Officers cover can add to the burden of legal expenses. The need to bring in lawyers and claims adjusters also, of course, depends on the value and complexity of the claim. Lawyers are being used in 19% of the total number of respondents’ open claims and loss adjusters in 55%. However, lawyers are used in 32% of open claims and loss adjusters in 63% by value.

As Figure 33 indicates, nearly half of respondents have sought to reduce the number of external lawyers they

By major class of business (e.g. Property, Casualty)

By sub class of business (e.g. US Property Cat treaty, US E&O)

By major broker

By territory of domicile of the underlying business (e.g. US, UK)

By type of claims (e.g. size, complexity, specialist nature)

0 100%

92%

38%

15%

0%

38%


Figure 32: How is your claims department structured?

Increased

Stayed the same

Reduced

No response

0 100%

8%

8%

38%54%

46%31%

0%

15%

Loss adjusters Legal advisers


Figure 33: How has the number of legal advisers and loss adjusters on your respective panels changed over the last three years?

04


use, either by rationalising their panel or bringing more of the work in house. It is noteworthy that the average proportion of respondents’ claims personnel with legal qualifications is more than one in four. A number of the respondents we interviewed believe that bringing legal work in house is not only cheaper than incurring external fees, but also gives them greater control over litigation and its costs.

Brokers currently have a key role to play in enhancing claims service within a subscription market. As Figure 34 highlights, the efficient and effective broking of claims can add significant value to the claims process, though in many respects participants would like stronger and more consistent performance from their broking partners. Respondents would in particular like faster updating of case

0 100%

N/A

Checking coverage on the submission of a new claim by the policyholder

Broking new claims/updates in a timely fashion to the relevant insurers/reinsurers

The handling of claims, if a delegated authority is granted

Collection and distribution of claims monies/fees from the market

The instruction of service providers

Chasing service providers/policyholders for updated information

Timeliness of updating case reserves and identifying redundant case reserves on bureaux systems

Involvement if there are coverage issues

Involvement if there are quantum of claim issues

38% 0%

38% 0%

23% 15%

38% 0%

31% 0%

38% 0%

31% 0%

38% 0%

46% 0%

No value at all Limited value Some value Significant value Highest value

15%

15%8%

15% 15% 15%

31% 15%

23%

8% 15% 38%

23%15%15% 8%

8%

8%

8%

31% 23%

23%

38%

31%23%

15%8%15%

15% 38%


Figure 34: In undertaking the following roles within the claims process, where do you consider that the broker ‘adds discernible value’ in the efficiency of the claims process?



reserves and identification of redundant reserves on bureaux systems, as well as more timely broking of new claims/uptakes (see Figure 35). A particular concern was the ever-growing legacy of claims from business in run-off. ‘The broker has little incentive to close the file as there is no new business coming in from the client’, said a participant. However, some brokers are now seeking to outsource the run-off of legacy claims or to find more expedient solutions to achieving finality.

More respondents believe that claims broking has deteriorated rather than improved over the past three years. This may in part explain why many insurers are seeking to take more aspects of the claims value chain in house, and in turn why the claims function headcount has increased. ‘In some ways we’re better geared up for claims than many of the brokers’, said a respondent.

0 100%

N/A

15% 8%

23% 0%

23% 23%

15% 8%

15% 8%

23% 0%

8% 0%

15% 8%

31% 8%

Not at all critical Not very important Neither/Nor Quite important Most critical

23%

23% 31%

8%46%

38%

8% 23% 46%

15%

15% 15%

23%

54%

8%8%

8%8%

8%8%

15%

38% 23%

23%

23%

54% 23%

23%

23%

8%

Checking coverage on the submission of a new claim by the policyholder

Broking new claims/updates in a timely fashion to the relevant insurers/reinsurers

The handling of claims, if a delegated authority is granted

Collection and distribution of claims monies/fees from the market

The instruction of service providers

Chasing service providers/policyholders for updated information

Timeliness of updating case reserves and identifying redundant case reserves on bureaux systems

Involvement if there are coverage issues

Involvement if there are quantum of claim issues


Figure 35: If brokers were to improve their performance in any of the following areas, which would you choose?

04


Enhancing claims processes

Respondents are looking to enhance their claims processes on a number of fronts. Major losses appear to have provided a catalyst for improvement, though much of the most important developments followed the events of 9/11 rather than the recent US hurricanes. For example, less than 40% of respondents have changed their investigation, reserving and reinsurance notification procedures in the wake of the 2004 and 2005 US hurricanes. It is also noticeable that most respondents believe that the settlement of reinsurance claims has slowed down since the recent, heavy wind storm activity.

The move to ECF should help to facilitate improvements, including faster and, in many cases, contemporaneous, communication with fellow insurers and shorter periods to settlement, as well as more effective review of overseas and outsourced claims (see Figure 36). As a consequence, almost all respondents have investigated the use of ECFs.

The growing use of documented claims guidelines since our 2003 survey is helping to enforce greater consistency and ensure critical steps are not missed in the processing and settlement of both high-volume and more complex claims. Many respondents believe that more systematic procedures could help to maximise reinsurance

Faster claims settlement potential

Enhanced claims MI

Other

The current proposals offer no benefits

Faster and simultaneous circulation of key claims information to both lead and follow underwriters

Ability to review claims handling activities in a remote location on a case-by-case basis (e.g. in relation to an overseas operation or an

outsourced services provider)

Ability to achieve faster claims settlement via on line/real-timeclaims conferences with third parties etc

0%

25%

75%

75%

42%

100%

83%

0 100%


Figure 36: Which key benefits, if any, do you consider that electronic claims files/repositories offer?



recovery and speed up the closure of redundant claims. However, some might argue that electronic access to these guidelines would be more effective than paper manuals. As Figure 37 highlights, few also include such key steps as the identification of subrogation and salvage opportunities and their subsequent collection in their claims guidelines, despite their potentially material financial impact.

Although all respondents apply authority limits for claims settlement, the control of other key areas including costs may be less rigorous. Around 15% of open claims files are subject to peer review, with reserving

accuracy being the key criterion for most respondents (see Figure 38). In contrast, the monitoring of cost control, claims settlement and adherence to guidelines is less of a significant priority.

The deployment of claims leakage reviews has become more commonplace since our 2003 survey. Yet, as Figure 39 indicates, the scope of the reviews still tends to be fairly limited and therefore potential cost savings may be missed. 15% or less of respondents cover fraud, reinsurance recoveries or salvage/subrogation, within their assessments.

04

The appointment of loss adjusters, lawyers and other specialists

The reserving of new claims

Follow-up on TBA reserves

Disputes/litigation

The use of ‘nominal’ reserves

Identification of reinsurance recoveries

Collection of reinsurance recoveries

Identification of salvage/subrogation opportunities

Collection of salvage/subrogation

Claims settlement

The review and closing of inactive/redundant claims

Other

The number/age of ‘TBA’ claims

None

100%

92%

38%

69%

77%

85%

77%

31%

23%

69%

77%

85%

15%

0%

0 100%


Figure 37: Around which of the following areas, if any, are documented processes/guidelines and controls in place to ensure consistency across each class of business?


Potential/actual fraud that was undetected/unproven

Unnecessary litigation and the associated costs

Failure to identify invalid claims

Over payment due to a misinterpretation of policy terms and conditions

Sub standard or erroneous work conducted by loss adjusters

Settlement in excess of expectations due to an unfavourable legal ruling

Settlement in excess of expectations due to failure to settle early at an economical value

The cost of ex gratia payments

The failure to identify salvage/subrogation opportunities and to act on these in a timely manner

Other

The failure to identify potential reinsurance recoveries

None

38%

8%

23%

38%

38%

23%

38%

38%

15%

15%

0%

38%

0 100%


Figure 39: Which of the following elements, if any, of claims leakage do you seek to measure regularly?

Reserving accuracy

Application of claims handler's technical knowledge

Level of settlement proposed/documented negotiations

Adherence to documented procedures (including, where applicable, Group controls)

Proactivity of claims handler in seeking to reach early settlement

Reporting requirements (both internally and, where applicable, to reinsurers)

Cost control/control of service providers (including experts)

Other

6.23

3.69

2.76

3.15

1.61

3

2.84

Average score

0.46

0 1 2 3 4 5 6 7

A score of 7 was awarded to the most important area, 6 to the next most important and so on.Source: PricewaterhouseCoopers 2006

Figure 38: Key areas of focus for open claims review/audit ranked by importance:

The use of cedant audits in relation to reinsurance portfolios has, unsurprisingly, increased in the wake of the 2004 and 2005 US hurricane seasons, especially when contract wordings or

coverage concerns occur. These reviews have identified a number of important weaknesses, including unrealistic early quantum of loss assessments and inconsistent case reserving.



04

Outsourcing

Many London Market insurers have been able to run relatively small claims departments thanks to the wide use of outsourcing, though larger units may become necessary as companies take on more SME and other commoditised business. Around 50% of claims by volume are outsourced to third parties apart from Xchanging, though higher value claims still tend to be dealt with in house.

Most respondents are quite satisfied with their claims outsourcing arrangements, though none are very

satisfied. The most important criterion for the selection of the service provider is perceived technical competence (see Figure 40). In other respects, the due diligence undertaken in choosing an outsoucer may be less rigorous than best practice would dictate. Barely 40% regard IT/reporting capabilities as important. Barely a quarter rate the transparency of performance measurement criteria under contract terms as critical.

The low priorities for reporting and transparency are surprising, given the fact that respondents judged poor MI

Perceived technical competence

Costs/cost control

Geographic location/coverage

IT/reporting capabilities

Range of services provided

Financial security

Transparency of performance measurement criteria within contract terms

Reputation

Pre-existing relationship

94%

69%

61%

41%

24%

42%

39%

26%

51%

0 100%


Figure 40: Important factors in selecting a third party to delegate claims handling authority:


and poor performance against service level agreement (SLA) criteria as the two greatest sources of dissatisfaction with claims delegation (see Figure 41). The need for more discernible measurement has been brought into focus by more frequent performance reviews and the general rise in the detail of SLAs, a substantial improvement in comparison to the findings of our 2003 survey. Around two-thirds of

service providers are now audited every year. At least three-quarters of respondents now include functional responsibilities, termination clauses and sub-delegation authority in their SLAs. In turn, effective IT and systems compatibility could become especially critical as insurers switch to ECFs, away from paper-based claims files and move into higher volume/lower margin SME and other commoditised business.

Services provided were not as originally discussed/thought to have been agreed

Poor quality management information provided

Generally poor performance against the agreed service level agreement (SLA)

Metrics agreed under the SLA were not, with hindsight, sufficiently challenging

Level of complaints from brokers/policyholders has been unacceptable

Poor timeliness of appointment of experts/specialists (e.g. loss adjusters)

Claim settlement levels have been unacceptable

Redundant case reserve levels have been unacceptable

Processing backlogs have been excessive

Litigation levels have been unacceptably high

None at all

18%

64%

82%

0%

9%

27%

27%

27%

18%

18%

9%


Figure 41: In which of the following areas, if any, have you been dissatisfied with your outsourced claims service providers?



04

Performance measurement

Effective MI is critical in measuring performance, yet metrics often lack granularity (see Figure 42). Around two-thirds of respondents have invested in significant or extensive improvements in their claims KPIs over the past three years (see Figure 43). Around 50% have sought to

enhance their claims MI suite. However, less than half are satisfied with their claims metrics and less than 40% satisfied with their claims MI suite (see Figure 44).

Respondents see problems with systems, data capture and data consistency as the greatest impediments to the usefulness

Extensive improvements

Significant improvements

Minimal improvements

No improvements

0 100%

31%

0%

38%31%

31%46%

0%

23%

Claims KPIs Claims MI Suite


Figure 43: To what extent, if at all, have you implemented improvements to your claims MI suite and set of claims KPIs/metrics respectively over the last three years?

Paid loss ratio

Incurred loss ratio

Attritional loss ratio

Large loss ratio

Ultimate loss ratio

Catastrophe loss ratio

93%

100%

93%

36%

29%

43%

0 100%


Figure 42: What claims management information is presented within your underwriting MI?


of their claims MI (see Figure 45). Data warehouses are helping to simplify and speed up MI production, with information packs updated and supplied every three weeks on average. However, a considerable amount of input and processing is still carried out by

hand. The list of desired improvements identified by respondents includes more focused exception or ad hoc reporting, standardised data from all locations and more user-friendly information packs.

Quite satisfied

Very satisfied

Neither satisfied nor dissatisfied

Quite dissatisfied

Very dissatisfied

0 100%

38%

8%

8%

23%15%

31%38%

0%

0%

38%

Claims KPIs Claims MI Suite


Figure 44: How satisfied are you with your existing claims MI suite and set of claims KPIs/metrics respectively?

Specific data items are not captured due to systems/other constraints

Information is not produced in a timely manner

Information is too high level

Information is too detailed

Inconsistent format of information

Ad hoc/bespoke reports cannot be produced easily

Other

Information is too expensive to produce

No constraints

77%

15%

15%

15%

38%

0%

54%

8%

8%


Figure 45: What are the constraints, if any, on the usefulness of the claims management/financial information produced?


Timeliness and regularity of communication with broker/policyholder

Number of claims fully settled

Productivity/average case load per handler

Proportion of settlement values within initial/experts’ advice

Speed of claims settlement

Number of claims repudiated

Level of backlogs

Level of claims leakage

Direct legal expense ratio (as % of GWP)

Direct loss adjusting expense ratio (as % of GWP)

Feedback on performance from brokers

Other

Indirect claims handling expense ratio (as % of GWP)

None

31%

62%

Reserving accuracy

Speed of appointment of experts

77%

31%

46%

23%

38%

38%

38%

23%

8%

23%

8%

31%

0%

8%

0 100%


Figure 46: Which of the following tangible claims department KPIs do you measure?

The most surprising of the MI findings was the general paucity of KPIs being produced. In particular, less than half of respondents measure speed of settlement (see Figure 46) or report this to the board (see Figure 47), even though they recognise that this is the most important criterion by which brokers judge claims performance

(see Figure 48). How to measure and report to the board on reserving accuracy may be a particular area for further development, and we would expect boards to demand greater transparency of the claims department’s performance in the future, particularly as premium rates soften in key markets.


04



Number of claims fully settled

Proportion of settlement values within initial/experts’ advice

Productivity/average case load per handler


Number of claims repudiated

Level of backlogs

Level of claims leakage

Direct legal expense ratio (as % of GWP)

Direct loss adjusting expense ratio (as % of GWP))

Feedback on performance from brokers

Other

Indirect claims handling expense ratio (as % of GWP))

None

0%

33%

Reserving accuracy

Speed of appointment of experts

50%

0%

33%

8%

17%

17%

25%

8%

8%

8%

8%

17%

0%

33%

0 100%


Figure 47: Which of the following claims KPIs do you regularly report on at board level?

0 100%

Reserving accuracy

Overall deployment of experts



Level of backlogs

Propensity to litigate against policyholder

N/A

38% 0%

46% 0%

8% 0%

8% 0%

15% 0%

38% 0%

Not at all important Not very important Neither/Nor Quite important Most important

8%

8%

31%

31%

38%

69%

46% 8%

15%

62%

23%

15%23%8%

46% 15%


Figure 48: In your opinion, how much importance do you consider that brokers attach to each of the following tangible claims-related KPIs in assessing insurer claims performance?


Very important

Quite important

Not very important

Not at all important

Neither important nor unimportant

No view

77%

15%

8%

0%

0%

0%

0 100%


Figure 49: How important is it to your organisation that it has a high-quality claims team?

People

The evidence from the latest survey suggests that claims teams are receiving greater appreciation and reward than our previous surveys would indicate. More than three-quarters of respondents now recognise that it is very important that they have a high-quality claims team (see Figure 49).

As a consequence, around a quarter of claims personnel’s pay is now variable, and linked at least in part to their companies’ overall performance. In turn, claims staff turnover is just 7% and vacancies are running at 4%, despite the competition for staff at a time when more than 90% of respondents expect their claims teams to continue growing.


04


‘ The way people approach claims is changing, but there’s still too many stale claims and too much money going to lawyers.’Survey respondent

London Insurance Market

Background


The London Insurance Market is a subscription market in which large primary risks and reinsurance covers are placed, and in 2006, comprises:

62 Lloyd’s syndicates (backed by individual Names or corporate capital);

UK-domiciled insurers and reinsurers; and

UK subsidiaries and branches of US, European and international insurers and reinsurers.

The London Insurance Market is a centre of underwriting expertise, especially in specialist risks such as aviation, marine and energy.

•

•

•

05

Contacts


If you would like to discuss any of the issues raised in this survey in more detail, please speak to your usual PricewaterhouseCoopers contact or one of the partners listed below:

Philip Calnan Telephone: +44 20 7212 4419 E-mail: [email protected]

Roy Clark Telephone: +44 20 7212 5670 E-mail: [email protected]

Paul Delbridge Telephone: +44 20 7212 3085 E-mail: [email protected]

Andrew Kail Telephone: +44 20 7212 5193 E-mail: [email protected]

Producing the survey

We are extremely grateful to all the organisations and executives who kindly gave their time to this survey and, in particular, the openness with which they discussed the issues facing their industry.

The research behind, and production of, this survey report involved a large team of people and we would like to thank the following for their valuable contribution:

John AshworthVincent BranchJean-Bernard CrozetChristine GrayAnne HagenGeorgina HaynesLouise HayterMark IrwinSarah MurphyHannah Wilson

PricewaterhouseCoopers International Survey Unit (Belfast)Alison BlairLorna McLernonPaul Schofield

06

Disclaimer: PricewaterhouseCoopers has exercised professional care and diligence in the collection and processing of the information in this report. However, the data used in the preparation of this report (and on which the report is based) was provided by third-party sources and PricewaterhouseCoopers has not independently verified, validated or audited such data. This report is intended to be of general interest only and does not constitute professional advice. PricewaterhouseCoopers makes no representations or warranties with respect to the accuracy of this report. PricewaterhouseCoopers shall not be liable to any user of this report or to any other person or entity for any inaccuracy of information contained in this report or for any errors or omissions in its content, regardless of the cause of such inaccuracy, error or omission. Furthermore, to the extent permitted by law, PricewaterhouseCoopers, its members, employees and agents accept no liability and disclaim all responsibility for the consequences of you or anyone else acting, or refraining from acting, in relying upon the information contained in this report or for any decision based on it, or for any consequential, special, incidental or punitive damages to any person or entity for any matter relating to this report even if advised of the possibility of such damages.

The member firms of the PricewaterhouseCoopers network (www.pwc.com/uk) provide industry-focused assurance, tax and advisory services to build public trust and enhance value for its clients and their stakeholders. More than 130,000 people in 148 countries share their thinking, experience and solutions to develop fresh perspectives and practical advice.

Unless otherwise indicated, ‘PricewaterhouseCoopers’ refers to PricewaterhouseCoopers LLP, a limited liability partnership incorporated in England. PricewaterhouseCoopers LLP is a member firm of PricewaterhouseCoopers International Limited.

For information on other insurance and financial services related publications or if you would like additional copies of this survey please contact Louise Hayter, Senior Manager, Global Insurance Marketing, on 44 20 7804 7083 or email [email protected]

© 2006 PricewaterhouseCoopers LLP. All rights reserved. ‘PricewaterhouseCoopers’ refers to PricewaterhouseCoopers LLP (a limited liability partnership in the United Kingdom) or, as the context requires, other member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity. Designed by the studioec4 18155 (08/06)

www.pwc.com

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