Insurance Underwriting: War and Inefficiency
A war continues to rage on between two wildly different views on how to approach underwriting: Art versus Science. As with most dichotomies in life, the truth lies somewhere in the middle.
Art: Some folks swear by the “art of the deal.” They view science, loss triangulations, probabilities, pricing algorithms, and so on as important support tools that the artisan underwriter should consult when structuring and pricing an insurance transaction.
Science: Others only look at underwriting through actuarial modeling lenses. They miss the bigger picture by ignoring the impact of social and jurisprudence trends, structure of the deal, wording improvements, and superiority or inferiority of their own underwriting team’s ability to assess risks and negotiate transactions.
The balancing act between art and science is a very customer segment dependent game: It is a lot more science than art in the consumer and small business segments and more evenly-weighed in the larger and more complex risks space.
The Executive Underwriting Brief
What are the must-know items for the executive or senior manager who doesn’t have a technical underwriting background? Your yardstick for measuring what is of the highest importance is to look at what part of the underwriting organization has the greatest potential of destroying your company’s balance sheet.
Don’t worry: Even if you don’t master all of the below concepts, having a basic understanding and asking the right questions should guarantee that everyone on your underwriting team will be laser-focused on these high-impact items. A full guidance is contained in The Insurance Management Playbook. Below are some suggested topics to probe:
> Systemic risk
> Rigor in pricing models
> Tight underwriting processes
> Limits and accumulation management
> Underwriting authorities’ delegation and control
> Fostering a learning and cross-fertilization environment
> Proper segregation of powers between sales, management, and underwriting
> Deep understanding of the concepts of rate change and effective rate change
I’ve always liked and tried to follow this overarching philosophy in underwriting: “If you like it, hoover it. If you don’t, decline it.” We should write as much target business as our balance sheet and accumulation models allow to and avoid writing any risk purely on an accommodation basis.
Irrespective of whether you are in the single-account or portfolio underwriting business, your high-level underwriting methodology should follow the SAAP model, which I learned at Gen Re. It stands for selection, analysis, attachment, and price.
It is a good mental model to assist you during the underwriting process. Price is not placed last because it is the least important element. Rather, it is vital to:
> Select the right type of risk you want to write;
> Analyze it and understand its exposures;
> Know at what level to position your deductible, excess, and other terms and conditions; and then
> Price it adequately
The SAAP model, whether actually performed by a human being or automated and run by an algorithm-powered machine should be supplemented with a layer of process and a coat of efficiency to supercharge it into SAPPEE. This will transform your organization and allow you to deliver more automation, speed, accuracy, predictability, control, and better customer service at lower cost.
Not all Risks and Customers are Created Equal
Your underwriting approach should be realigned in terms of processes, tools, and resource allocation to better suit the dynamics of your different customer segments. Companies’ operating models should be re-engineered along the following production lines: Black Box, Non-Fast Track, and Fast Track.
Black Box (BB): The BB underwriting approach works by a process of elimination. You ask a set of questions and, unless you receive an unsatisfactory answer, the target risks should be “hoovered.”
I will use a non-insurance example to illustrate the process. I got my first credit card from Wells Fargo Bank when I was eighteen years old in college. Their on-campus sales representative asked me the following questions:
Are you above eighteen years of age?
Are you a full-time student?
Have you ever defaulted on a credit card or filed for bankruptcy?
I answered yes to questions one and two and no to question three. I then got immediately preapproved for my first $1,000-limit credit card. I proceeded to provide my name, address, and social security number. That’s it.
I believe that the majority of insurance products in the consumer as well as small to mid-size business customer segments should be underwritten using the BB approach. The Insurance Management Playbook goes through real life examples of how the BB underwriting approach can be designed and applied irrespective of the products underwritten.
NOTE: The BB approach is supposed to be customer-friendly as well. Don’t ask customers to fill out lengthy proposal forms if you can obtain answers to most queries by accessing publicly-available data through credit bureaus, social media, and other channels.
Non-Fast Track (NFT): NFT can also be labelled fine cuisine, bespoke, or Lamborghini underwriting approach. It is the tailor-made process that is associated with a smaller universe of truly unique and/or complex underwriting decisions for risks such as larger financial institutions, oil and gas, and construction companies. It is very people-dependent and not highly automated.
Fast Track (FT): Think of FT as the middle-of-the-way production line wherein the process is the same as BB to the tune of, say, 85 to 90 percent, but you sometimes need to take the risks off the main BB assembly line to cater for special scenarios à la NFT.
Let’s step away from the world of insurance and analogize to the automotive industry. Take the Lexus ES 300 or Mercedes C-class AMG cars. They are, like most vehicles, manufactured using an automated BB-style assembly line with machines pretty much doing most of the work in a highly-efficient method that minimizes human intervention. There are, however, Lexus cars that feature finely-stitched Coach leather seats instead of the normal kind and Mercedes C-class vehicles that come with an AMG kit. These cars, which probably represent less than 5 percent of any given year’s total production, actually get taken off-line to be fitted and then returned to the BB production line.
The same approach should be used in underwriting for, say, a risk that experienced a small claim, faster than normal sales growth, or an issue with premium payment. It should be taken off the BB production line, analyzed, and either put back in the BB queue or handled by an underwriter in a NFT-like fashion.
What about Underwriters?
Your underwriters come in different flavors: Market facing, line/product/technical, and referral. Technical and referral underwriters should visit a broker or customer and take them out to lunch every now and then to remain in touch with the market realities.
They don’t have to be with customers and distributors for breakfast, lunch, and dinner. However, being chained to a desk and reading about the market in a report just isn’t the same as experiencing the market firsthand. Encourage them to get out there!
I was brought up on the underwriting side of the insurance business and still have no clue why most underwriters remain mono-line technicians. Why can’t we train our staff to become multi-line underwriters so they could underwrite the customer and not just the product? The truly specialized, tough, and complex risks do need to be handled by specialists, but these risks account for a small fraction of our industry.
> Underwriting is a hybrid between art and science.
> Be aware, as the Executive, of the key drivers and main issues in the underwriting space.
> Choose an underwriting philosophy that you are most comfortable with, so long as it’s not cash flow underwriting!
> Avoid overreliance on tools and models. They are essential but not a substitute for underwriting judgment.
> Use SAAPPE as an approach for single account and portfolio underwriting. It gives you a competitive edge and helps turbocharge your underwriting with an efficient process.
> Not all risks are created equal. Underwrite to the customer segment and design your processes along the following production lines:
> Black box.
> Non–fast track.
> Fast track.
> Encourage your underwriters get out there and meet with clients and brokers to remain grounded in the market’s reality.