Hard Market Upfront Underwriting: Agencies Yesterday and Today

Historically, the P&C market rode a seven-year wave, give or take. The market would be soft for around seven years, hard for around two to three years, and repeat. During the soft market phase, the carriers who had plenty of surplus and were unwilling to compete on price wrote the accounts that came their way and waited for the hard market. When the hard market arrived, they had the surplus, the capacity, to write everything at their price. They would grow significantly and profitably at this stage.

The soft market companies would inevitably run out of surplus, which facilitated the next hard market. Hard markets are ALWAYS caused by surplus shortages, not a lack of profit, and a lack of profit does not necessarily drive surplus shortages. These companies would then sit on the sidelines watching their book dwindle, which they wanted to happen because by losing premiums, it was easier for their capacity to catch up. When they had enough surplus to chase price again, they would and the market would enter a soft stage.

The exact timing depended on how fast these carriers decreased rates, who was cheating or simply incompetent in their reserving, and luck. The luck could be good or bad.

The timing changed after 9-11. The industry entered both the longest soft market likely in history and, for three years following the credit crisis, the most severe soft market. Now, the hardest market since at least around 1990 seems to be slightly moderating.

In the old days, there were also soft market agencies and hard market agencies. Hard market agencies were generally better underwriters. They would consistently achieve loss ratios in the 30s and 40s. These agencies were the best upfront underwriters. The offset was they grew slowly, if at all, except in the 24- to 36-month hard markets every seven or so years. And that was acceptable to smart carriers because those agencies subsidized the bad upfront underwriting agencies enough that carriers still profited.

This is not the case today. The number of good upfront underwriting agencies has significantly decreased, but they still exist, and 100% of the ones I know would like to toss their carriers into Dante’s hell for the way they’re treated. Most carriers, regardless of what they say, really could not care less about excellent loss ratios today (unless the carrier has financial problems). Insurance companies cannot come right out and say this, but their contingency agreements generally do not pay all that well for good loss ratios. That about says it all.

Why wouldn’t a carrier care about great loss ratios? Because loss ratios are only one factor in determining a company’s health and future. Looking at the bigger picture, the combination of growth and loss ratios must be considered, at the very least. Especially important is identifying the best intersection of growth and profit. Carriers and agencies with the best loss ratios generally grow more slowly. Carriers have generally identified the optimal loss ratio is around 55% because that is where they will grow at the right pace to optimize their value. At a 45% loss ratio, they will grow too slowly. They will lose too much market share, which is happening because out of 1,100 P&C carriers, nine now account for 53% of all the premiums. The other 1,091 carriers cannot afford to lose more market share because a high profit margin at $0 premium is not much profit. Yet, at a 65% loss ratio, they’ll not be adequately profitable. As in all things, balance is good.

Historically, too, insurance company actuaries and models were inadequate to aim precisely for the bull’s eye. The carriers that now possess the highest quality predictive models (and some companies seem to possess rather poor algorithms because not all predictive models are equal) can hit that bull’s eye over and over. They no longer need the agency with a 45% loss ratio subsidizing the agency with a 65% loss ratio.

Historically, agencies that were great upfront underwriters had huge profit margins, and they did not need to grow as quickly as carriers did. These agencies were, in Professor Michael Porter’s famed nomenclature, Cash Cows. They made so much money from contingencies and their retention rates were so high, they really did not need to write much net new business. The model carriers have now adopted is killing these cash cows. Whether those agencies are dying quickly or slowly, the market does not have room for Cash Cows, or at least not for agencies that generate high profits from contingencies while growing at a snail’s pace. I sympathize with these agencies, and I understand their frustration.

The old ways are dying. Either adapt or die. Or become really creative because a market does exist for high-profit books. That market is in alternative risk. The alternative risk market is designed for low loss ratio business. It is folly to believe you can talk sense into the heads of admitted carriers’ executives to settle for a 45% loss ratio and 4% growth. But if you want to develop this book in a captive environment, you might create a gold mine.

Developing a captive, especially in this manner, is 10 times easier said than done. However, this is the remaining part of the insurance world that truly puts their money where their mouth is when it comes to rewarding quality upfront underwriting. The first step in making this a reality is the psychological acceptance that your only option is to go down a radically different path if you are committed to upfront underwriting and being justly rewarded for it.

The second step is meeting the people who can guide and coach you. This is a sophisticated and complex part of the insurance world. Fire everyone who tells you they have an easy solution, or at least laugh at them, because other than convincing people who do not know better that this solution is simple, nothing about it is simple. And there are many people willing to take advantage of agents who want the solution without the work to vet the vendors. You must learn enough to do the initial vetting and then hire people who will do the rest of the vetting. Don’t trust anyone without verification in this space.

The third step is to then work with the experts you hire to complete a feasibility study. The fourth step is building out the program, including taking a deep breath to assess your own risk-taking appetite. Done well, I don’t think these are all that risky, but they are riskier than the traditional market because someone must initially invest capital. They are riskier because you may be asking clients to take on additional risk. These are riskier models, which is why greater care is required upfront; however, good upfront underwriting agencies are accustomed to applying considerable care.

Again, discussing this is much easier than executing it. However, if you truly believe in upfront underwriting, this is the only option today where you can get your just reward. And if your carriers were to become upset for moving all the good business to a captive, so what? Give them the option of paying you more for the business you’re moving rather than them getting a disproportionate amount of the profits.

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NOTE: The information provided herein is intended for educational and informational purposes only and it represents only the views of the authors. It is not a recommendation that a particular course of action be followed. Burand & Associates, LLC and Chris Burand assume, and will have, no responsibility for liability or damage which may result from the use of any of this information.

None of the materials in this article should be construed as offering legal advice, and the specific advice of legal counsel is recommended before acting on any matter discussed in this article. Regulated individuals/entities should also ensure that they comply with all applicable laws, rules, and regulations.