The Art of the Possible

By Geoff Smith, Strategic Advisor to FirstBest

The property/casualty insurance industry is in turbulent times. The profitability peak of 2006 is now on the downturn, combined ratios are rising, investment returns are disappearing, and the economy continues to shrink. So, where does an insurance carrier turn to meet its most significant challenge; maintaining profitability?

Having spent my insurance career with underwriting as a foundation, I have long believed in two key components to success. First, that risk selection based on adherence to sound, proven underwriting rules and guidelines will see you through the most challenging of times. And, that it’s essential to ensure a pricing approach that differentiates exposures and more accurately prices risk selection. The question today’s turbulence then poses is “How can we minimize the impact of current market forces to maintain underwriting profitability?”

Forty years ago, underwriting was considered an art form. Line underwriters had to follow company underwriting guidelines and pricing parameters, but even the least experienced still had a great deal of latitude. Beyond the customer application completed by an agent, underwriters knew little about the customer, leaving room for subjective decisions. Thus, the “art” of underwriting was realized by the underwriter’s ability to craft a solution for the risk selection and pricing opportunity for each individual risk presented - to determine an acceptability decision.

Underwriting results and related profitability dissolved in the mid 1970s, forcing the art form to evolve into a more “scientific” approach, beginning with personal auto insurance. Today, personal lines risk selection and pricing methodology is more of a science than an art. However, a more modern artistic aspect to underwriting has evolved - in the form of predictive models, based on actuarial data and analysis. These models are carefully sculpted and deployed in the risk selection and pricing process. They remove subjective underwriter judgment for more consistent adherence to underwriting rules and pricing models. The result? A more predictable, profitable outcome.

Historically, commercial lines profitability has shown more variability than personal lines because commercial lines underwriters – experienced or not - influenced the risk selection and pricing outcome. Thankfully, the “art plus science” approach, which has become a personal lines institution, is moving into commercial lines, particularly in the small-to-medium size risk segments. This blended approach is achieved by investing in a technology-based underwriting management system that codifies the company’s underwriting rules and risk selection process. Such a system automates the underwriting process so that a large percentage of risks go to straight-through processing and only complicated and exceptional risks need an artist/underwriter’s personal attention.

If your underwriting methods produced profitable results during the industry’s profitability peak, imagine how much you’d benefit from deploying the right commercial lines underwriting management system in today’s market. You may not only maintain profitability; you might very well improve it.

After all, it’s the art of the possible.