ANAND PATEL: Hello and welcome to (Re)thinking Insurance. I'm your host, Anand Patel and today we'll be exploring the dynamics of the commercial lines market cycle. This podcast is inspired by our video series, 'Thinking Unbound', in which we explore the latest trends and challenges facing the commercial and global specialty markets. If you'd like to watch the full video on this topic, please search for Thinking Unbound on our website, wtwco.com. Today I'm joined by our guests Paul Higham and Derric Howard. Thank you for being here.
We have started to see the first signs of the market softening following the period of a hard market and which was very profitable for insurers. Given you're both experienced individuals who've seen both sides of that market, what would the lessons be that you've learned from the practices of managing a soft market?
PAUL HIGHAM: Thank you, Anand. Yeah, so I think it's useful to think of this in a context of four cycles, a cycle management, so of the market cycle. So we think of this in terms of a restoration phase, a confidence phase, a pain phase, and then a remediation phase.
So the restoration phase is really about when prices harden, insurers start to get returns to profitability and growth opportunities emerge. Whilst insurers also convince themselves or convince the market that they're going to learn the lessons from the last soft market. And but like I said, those growth opportunities emerge. So it's quite difficult.
We then flow into the confidence phase where profits remain high, but then price adequacy starts to reduce as competition increases. But insurers remain confident that they're still doing the right thing, and they can outcompete the market.
As that continues through time, we enter the pain phase, as price adequacy reduces and insurers again start to understand that price adequacy is below where it needs to be. But there's also always some insurers who believe they've got the secret sauce and continue to drive that market pricing down. And then we enter the phase of remediation where enough is enough. The soft market has gone too deep and prices start to harden through the remediation phase.
So I think in the context of those four stages of the cycle, what's important for insurers to understand is, when is enough enough? Have that best view of when technical price is too low and therefore, make strong decisions in terms of understanding when they need to pull the plug and push prices. So really, for me, it's around investing in technical capability when the opportunity arises.
DERRIC HOWARD: I think it's worth thinking about maybe two key topics one being cultural and one being technical. And when I think about culture and how insurers should be behaving across these different phases of the cycle, it's really about alignment and transparency. If you think about technical functions as underwriting, pricing, reserving, and capital, how well are they communicating and how clear is that communication about what they see happening in the business and what they're doing about that, which leads into the technical side of things.
You can have, in the cycle that we've seen over the last few years, underwriters taking significant action around rates, around terms and conditions, capacity, limits. All of these things are having a contribution towards improving the PNL of the insurer. How well-aligned are pricing models to identify not just a change in price, but a change in the underlying exposure and the ramifications of that having-- what the ramifications of that are having on the portfolio as a whole? Same thing with reserving.
Long past are the days where you can wait for a year or two's business to earn through before reflecting underwriting actions in loss ratio pix. So cultural side, communication, technical side, do you have the capability to identify all of the things that are happening across a business and doing something about that actively to make sure that there's alignment across those functions and that you're reflecting the real picture of the risk that an insurer is holding?
ANAND PATEL: That's a really interesting discussion there around the cultural and the technical challenges that businesses are facing. And from what you're saying, the importance of being able to recognize exactly where you are within that performance cycle at a very early stage is really important for the reserving actuaries to be able to reflect that in their selections.
Just thinking through the polarization in that cycle in terms of the soft market and then the hard market, what do you think are the key differences from an underwriting perspective in terms of the way that underwriters should be responding, their engagement with the brokers, the distribution channels they're using, and how they kind of interact with clients?
DERRIC HOWARD: When I think about what an underwriter has been experiencing over the last couple of years, really, we have a new generation of underwriters and a new generation of brokers that have never seen a hard market and have to deal with the implications of what that really means and thinking about how to address customer challenges and staying focused on the customer at the same time as focusing on your own business is absolutely critical. So what is a reasonable amount of action to be taking against a loss-free customer versus one which isn't loss-free?
But this environment where rates are increasing, commissions might be decreasing, distribution focus is changing, emergence of alternative capital and captives are also a feature of this part of the market, it's a different sort of a challenge and environment for an underwriter to work in and for brokerage colleagues to be working through as well, because they're going to be representing slightly different parts of the value chain fundamentally. And that's really compared to in a softer market where underwriters are trying to mitigate damage in many ways, where you know prices are coming down, you know you're going to have to be flexible around terms and conditions and other factors.
But it's a choice between holding technical rigor and losing market share. So that's a very difficult balance to strike to try to get the best possible outcome as an insurer, as a broker, as a customer versus what you see in a hard market like we like we have over the last couple of years.
PAUL HIGHAM: Yeah. Thanks, Derric. I think the only other angle I'd probably add to that is, is how the cultural aspect of underwriters is steered through the organization. So and I think that comes down to having a really clear sort of cycle managed strategy as a board and as an insurer. So it sounds really simple, but making sure that underwriters and distribution teams noses are all pointed in the same direction have a really clear understanding of what that insurer's strategy is at that point in the cycle.
Too often, I think from our position, we've seen that go a little bit awry at insurers. So making sure that there is a really clear strategy for the organization to what to do and what the what the ambitions are at any point in the cycle, and also having a view on how that will change as those lead indicators come through the market and come through that insurer to indicate changes in through that cycle. So what will insurers do as the market softens, for example, are making sure those that playbook of strategies is in place and all your teams are aligned.
DERRIC HOWARD: And I think that feeds naturally into a couple of different topics around portfolio management and annual planning as well. Whatever that strategy is, whether it's a growth-focused strategy, a profit-focused strategy, an opportunistic strategy, it's not necessarily the strategy that's the differentiator. Having a strategy and sticking to it is a differentiator, I believe.
But taking that activity and focusing it on portfolio management to make sure that you understand the risks that you have in the book of business and that you're addressing those risks in a conscious, collective way for the for the greater success of the organization, that can oftentimes be realized within annual planning, which is a difficult and oftentimes time consuming process. But it's a point at which top and bottom line and multiple functions have to come together and agree. This is where we want to proceed, and this is how we're going to proceed over the next year, two years, three years, five years.
ANAND PATEL: I think that's a really good point that you just mentioned there around the alignment of business planning and portfolio management practices. That's something that we hear time and time again that actually, those two processes aren't aligned. They're not reflective of the needs of the market at the point in the cycle in which it is.
Do you agree with those views? And what could businesses do to get better alignment between those two practices?
PAUL HIGHAM: Absolutely. And like I said a few minutes ago, so we're in a privileged position that we see, a vast majority of the market, we understand insurers capabilities, what they're good at, what they're what they're looking to improve. And we can align that understanding to the business results. So those insurers that we see are succeeding through the market cycle are those that are investing in business planning and portfolio management.
So and what are we seeing in terms of emerging trends there? So from a business planning perspective, we're seeing investment in really granular portfolio management and business planning capability. So bottom-up planning, running multiple scenarios over your existing portfolio, looking at internal external factors, but also then starting to bring in the impact of capital on those various scenarios. So rather than capital being looked at the later stages of business planning and bringing that into your various scenario modeling and understanding and optimizing your portfolio shape based on return of capital, that's a really important factor. And we're seeing that emerge pretty strongly through insurers at the moment.
DERRIC HOWARD: And I think it's worth noting one of the trends that we see a lot of in the insurance consulting and technology business is the movement towards within commercial lines and specialty business more sophisticated and more granular pricing. And also, introducing new concepts, new processes, like machine learning, into not just pricing but also reserving practices. And these can help to identify trends and do it more quickly than what we've seen in the past.
PAUL HIGHAM: Thank you. I think the only other point I'd bring on that just builds on that final point is we've all been through business planning processes. We've all seen the challenges and how that business plan then turns itself into portfolio management in terms of how you're performing against your business plan. One of the challenges can be that lag in your ULR reflecting the activity that's being undertaken.
And that can go two ways. It could be a delay in noticing downward trends. So actually then putting you on a back foot in terms of how you respond. But it can also sometimes see some delays in recognizing and reflecting the improvements you've made in an account. So actually, the concept that we're seeing insurers work to at the moment is more granular reserving, really aligned with underwriting and pricing teams.
So bringing agreements up front, for example, that if you manage a certain segment of your portfolio off, it will impact a ULR by x number of points. And as that activity runs through the portfolio, seeing your ULR reflect in real time rather than the, we'll look at that again next quarter. So that's something that we're seeing real advancements in insurers at the moment.
ANAND PATEL: Thank you very much. Very interesting insights there in terms of how to manage that cycle, clear focus around having that technical focus and the accuracy in the results and the emerging performance. Paul and Derric, thank you. It was great to hear your perspectives.
And to all our listeners, thank you for joining us today. And if you found this interesting, then make sure to join us on future episodes of (Re)thinking Insurance.
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