5 P&C underwriting metrics to increase profitability Matthew Tierney, Principal, Business Advisory Services, Grant Thornton LLP Joseph F. Morris, Founder and President, P&C Insurance Company Strategies, LLC When it comes to maximizing underwriting revenue, many property and casualty (P&C) insurance companies are missing some key ingredients. Many firms even the large international P&C companies do not generate the data or metrics they need to monitor and manage their underwriting operations effectively. In other cases, insurers are choosing to focus only on written premium volume and calendar year combined ratios, which are only part of the story. The two roads to new business 1. Direct underwriting Insurance carriers that source their own business 2. Indirect/program business Insurance carriers that empower others to write business on their behalf: The insurance carrier makes an agreement with a managing general agent (MGA) to source policies for the carrier The MGA can underwrite and price business on its own and issue on the carrier s paper The carrier must rely on the MGA s systems and metrics As we look ahead, it will be critical for companies to generate increased margins from underwriting since low-interest rates mean investment operations will contribute less toward total return on equity (ROE). It wasn t that long ago that a P&C insurance company could generate 75% of its ROE goal from its investment portfolio. For example, if a company s ROE goal is 12%, 9% would be produced from investments and 3% from the underwriting operations. To produce a 3% underwriting return, a company could write to a 98-100 combined ratio, depending on a company s operating and investment leverage. In today s low-interest rate environment, a company will need its underwriting operation to produce approximately 50% of its ROE goal which translates into a 90-92 combined ratio. In short, getting a handle on underwriting metrics can significantly boost profitability. How an insurer sources business must be a part of any improvement initiatives as well. To improve profitability on underwriting margins, insurers must calculate and analyze five key metrics on at least a monthly basis.
Metric No. 1: New business success rate Success means writing new business. Understanding where new business comes from means developing and analyzing metrics to identify where the P&C insurer has been successful (or unsuccessful) in writing new business in the past. Some key guideposts are measuring submission activity through to new business premium and average new business account size written. In addition, it is critical that these metrics be generated at an underwriter, agent, line of business and product to fully understand where the insurer s operating performance is exceeding or falling short of expectations. Metric No. 2: Renewal retention statistics Growing a company s premium volume begins with retaining existing clients. Insurance companies should measure their ability to retain existing clients on both an account and premium basis. For example, by measuring both accounts and premiums, a company will be able to determine if they are more or less successful in retaining large versus small clients. Similarly, other measures can be used to identify the most profitable customers. The metrics should reflect more than just volume the quality of the business can be even more important. Example: New business success rate report Current year Prior year % increase Submissions received 10,000 11,500 15.0% Quotes 7,000 8,300 18.6% Quote ratio 70.0% 72.2% New business bound 2,200 2,750 25.0% Hit ratio 31.4% 33.1% Bound to submission ratio 22.0% 23.9% New business premium $7,700,000 $11,200,000 45.5% Average new business account size $3,500 $4,073 16.4% A gap analysis can identify target improvement areas Grant Thornton LLP often works with insurers to analyze operational platforms and/or systems to get them to a target underwriting model. We recommend performing a gap analysis that benchmarks the company s underwriting operations with best-in-class companies and processes the gaps that emerge can be isolated, and relevant strategies can be built. In most cases examining and acting upon the five metrics we discuss here will assist in this process. 2
Example: Renewal retention ratio report Prior year Current year Counts Premium Counts Premium Expiring available for renewal 5,750 $23,000,000 7,143 $30,000,000 Renewed 4,350 $18,000,000 5,500 $21,000,000 Renewal retention ratio 75.7% 78.3% 77.0% 70.0% Like new business, the renewal retention statistics should be produced at an underwriter, agent, line of business and product to fully understand where the company s retention results are exceeding or falling short of expectations. The denominator for the retention ratio calculation should be the expiring number of accounts and corresponding expiring premium immediately before the expiration month. The numerator for the retention ratio calculation should be the number of accounts renewed and the corresponding renewal premium, excluding price and exposure changes at renewal. Any further analysis should take your distribution channels into account. Oftentimes the metrics related to direct and/or indirect business can increase your ability to analyze the retention ratios even further. The metrics should reflect more than just volume the quality of the business can be even more important. Metric No. 3: Pricing With the wide range of rating algorithms and classes and lines of business, building a data-driven rate monitoring database and reporting mechanism is the most challenging metric for an insurance company to generate. Yet, there is no metric more important in determining if an insurance company is on target to achieve its underwriting margins than how its book of business is priced compared to manual rate s and rates charged on the expiring book of business. When developing pricing metrics, comparisons need to track price s for new business separate from renewals and changes in its manual rate s separate from changes in judgmental (discretionary) price s. Pricing s should also be measured by underwriter, agent, line of business and product, and include additional coverages, not just base rate changes. Also, price s should be adjusted for changes in limits of liability and deductibles. Example: Price- report Manual rate Prior year Current year % increase Discretionary modifications Actual price Manual rate Discretionary modifications Actual price Manual rate Discretionary modifications New business 1.0 0.865 0.865 1.075 0.880 0.946 7.50% 1.73% 7.63% Renewals 1.0 0.920 0.920 1.075 0.940 1.011 7.50% 2.17% 7.67% Total 1.0 0.900 0.900 1.075 0.918 0.986 7.50% 1.94% 7.65% Actual price 3
There must be an appropriate of granularity from both indirect and direct business for pricing the ultimate goal for any insurer is a uniform platform to run those pricing metrics. This is not always possible because of aging legacy systems, which can be financially prohibitive to replace. For many insurers, it seems more palatable to maintain the existing underwriting, policy issuance and claims systems. This leaves them in a quandary not getting the data they need, but believing their situation is less painful than making a major investment of time and money in new, up-to-date systems. Many insurers haven t considered viable bridge solutions, which are designed to squeeze more out of existing systems without major investments. When purchasing new technology is not feasible, management should fully explore this option. Metric No. 4: Execution of claims best practices If you asked a P&C insurance CEO or chief claims officer to describe their claims best practices, they might list the following: Assignment and early contact Coverage confirmation and analysis Investigation Evaluation Reserving Litigation management Negotiation and disposition Subrogation, special investigations unit and salvage/recovery Reinsurance and notification File management and documentation However, if you ask these same executives to produce a financial report that lists metrics that monitor the of execution of these claims best practices, few would have metrics to share with you. Each of these claims best practices can be measured, and ultimately, these measurements would indicate if a company is overpaying claims. For example, assignment and early contact can be measured in three areas: No matter what strategy the insurer uses, speeding up the process is a clear best practice. 1. Time between the date of loss and the date the claim was reported to the company 2. Time between report date of the claim and date assigned to the claim examiner 3. Time between date of assignment and date that examiner contacted all applicable parties for the claim Some of these claims best practices will be difficult to quantify by way of an automated report. However, quality assurance reviews could be used to supplement quantitative metrics in this area. No matter what strategy the insurer uses, speeding up the process is a clear best practice. Historical data supports that the longer the time frames, the more likely the examiner will need to pay a higher amount to close the claim file. 4
Metric No. 5: Accident year limited loss and loss adjustment expense ratio Limiting losses to a frequency in an accident year loss and loss adjustment expense (LAE) ratio is the best way to evaluate the performance of an underwriting operation. An accident year approach is better than a calendar year approach because prior year reserve changes are properly reflected in their appropriate accident year. Additionally, by limiting losses to a frequency layer, it allows insurers to understand how the occurrence or absence of large losses affects current profitability. Finally, by excluding un LAE (the costs of a company s in-house claims staff), this metric helps insurers zero in on all external costs of the claim adjustment process. Like the metrics described earlier, companies should generate accident year loss and LAE ratios at the underwriter, agent, line of business and product, and the reports should include the three latest accident years in order to review trends over time. Example: Accident year loss ratio report (Dollars in thousands) Liability (Target ratio = 38.0%): Earned premium Accident year limited loss and LAE ratio ($100,000 loss limit) Paid losses and LAE Outstanding reserves Reported losses and LAE IBNR reserves Losses and LAE incurred Loss and LAE limited ratio 2011 accident year $4,250 $950 $550 $1,500 $325 $1,825 42.9% 2012 accident year $5,500 $300 $1,050 $1,350 $650 $2,000 36.4% 2013 accident year $5,750 $115 $800 $915 $1,200 $2,115 36.8% 2011 2013 accident year $15,500 $1,365 $2,400 $3,765 $2,175 $5,940 38.3% Property (Target ratio = 22.5%): 2011 accident year $2,500 $250 - $250 $75 $325 13.0% 2012 accident year $3,250 $350 $80 $430 $125 $555 17.1% 2013 accident year $4,750 $100 $750 $850 $500 $1,350 28.4% 2011 2013 accident year $10,500 $700 $830 $1,530 $700 $2,230 21.2% Total: 2011 accident year $6,750 $1,200 $550 $1,750 $400 $2,150 31.9% 2012 accident year $8,750 $650 $1,130 $1,780 $775 $2,555 29.2% 2013 accident year $10,500 $215 $1,550 $1,765 $1,700 $3,465 33.0% 2011 2013 accident year $26,000 $2,065 $3,230 $5,295 $2,875 $8,170 31.4% In the above example, a target loss ratio of 38.0% for liability was determined as follows: Combined ratio to achieve a 12% ROE 92.0 Less: Underwriting expense ratio (32.0) Un LAE ratio (3.0) Excess loss & LAE ratio above the frequency layer (19.0) Targeted loss and LAE ratio 38.0 5
Conclusion Continued low-interest rates mean that P&C leadership teams are facing mounting pressure to generate heftier margins from their underwriting operations. Now more than ever, these firms will need to generate the right data and metrics to help them determine what s profitable and what s not. Look for more Grant Thornton thought leadership at: http://www.grantthornton.com/industries/financial-services/ insurance.aspx. Other recent articles have included: Federal Insurance Office issues initial report proposing major insurance industry changes http://www.grantthornton.com/issues/library/articles/ financial-services/2013/ins/12-fio-report.aspx Finding value in ORSA http://www.grantthornton.com/issues/library/articles/ financial-services/2013/ins/07-finding-value-orsa.aspx Contacts Matthew Tierney Principal, Business Advisory Services Grant Thornton LLP T 215.701.8822 E matthew.tierney@us.gt.com Joseph F. Morris Founder and President P&C Insurance Company Strategies, LLC T 215.901.0334 E jmorris@pcicstrategies.com Continued low-interest rates mean that P&C leadership teams are facing mounting pressure to generate heftier margins from their underwriting operations. This article is adapted from an original version appearing in the Wholesale Insurance News magazine of the American Association of Managing General Agents. Connect with us grantthornton.com twitter.com/grantthorntonus linkd.in/grantthorntonus Grant Thornton refers to Grant Thornton LLP, the U.S. member firm of Grant Thornton International Ltd (GTIL). GTIL and its member firms are not a worldwide partnership. All member firms are individual legal entities separate from GTIL. Services are delivered by the member firms. GTIL does not provide services to clients. GTIL and its member firms are not agents of, and do not obligate, one another and are not liable for one another s acts or omissions. Please visit grantthornton.com for details. 2014 Grant Thornton LLP All rights reserved U.S. member firm of Grant Thornton International Ltd