Seven steps to managing the cycle

Refusing to ‘follow the herd’, providing the right incentives for underwriters, and investing in risk management tools are among key recommendations for managing the insurance cycle in a report published today.

July 12, 2006 – Managing the Insurance Cycle, published by Lloyd’s, the world’s leading, specialist insurance market, warns that considerable uncertainty remains over prices and conditions in the commercial insurance market following last year’s record hurricane season.

Historically the insurance cycle has been characterised by peaks and troughs that reflect the rise and fall of insurance prices. It alternates between periods of soft market conditions, when premium rates are stable or falling and insurance is readily available, and periods of hard market conditions, when rates rise, coverage becomes difficult to find, and insurers’ profits increase. As the market softens to the point that profits diminish or vanish completely, the capital needed to underwrite new business is depleted, and insurers who have not underwritten prudently can lose millions.

Lloyd’s report recommends seven key steps for ensuring that the industry becomes less unpredictable and underwrites on a sustainable basis for the benefit of both policyholders and insurers. These are:

  • Don’t follow the herd.

  • Invest in the latest risk management tools.

  • Don’t let surplus capital dictate your underwriting.

  • Don’t be dazzled by higher investment returns.

  • Don’t rely on ‘the big one’ to push prices upwards.

  • Redeploy capital from lines where margins are unsustainable.

  • Get smarter with underwriter and manager incentives.

Rolf Tolle, Lloyd’s Director, Franchise Performance, said:

“In the past, insurers have simply accepted the insurance cycle, seeing it as a force of nature with an uncontrollable impact on their business. But at Lloyd’s we believe that insurers now have the information and the tools they need to manage the cycle much more effectively.

“Market conditions are changing – with rates softening in a number of lines – and we believe that it is now more important than ever for insurers to take action. We have already done a lot of work on this at Lloyd’s to encourage underwriters to manage the cycle, but the real test of a soft market is still ahead of us and there remains much to be done.”

Lloyd’s commissioned the report from the Economist Intelligence Unit as part of its 360 Risk Project, which aims to generate debate about today’s key risk issues and how best to manage them.

About Lloyd’s

  • The full report, including an executive summary, can be seen at from Thursday, December 7.

  • More information on each of the recommendations:

    • Don’t follow the herd. Insurers need to be prepared to walk away from markets when prices fall below a prudent, risk-based premium.

    • nvest in the latest risk management tools. Insurers must push for continuous improvement of these tools based on the latest science around issues such as climate change, and make full use of them to communicate their pricing and coverage decisions.

    • Don’t let surplus capital dictate your underwriting. An excess of capital available for underwriting can easily push an insurer to deploy the capital in unsustainable ways, rather than having that capital migrate to other uses such as hedge funds and equities, or returning it to shareholders.

    • Don’t be dazzled by higher investment returns. Don’t let higher investment returns replace disciplined underwriting as base rates creep up on both sides of the Atlantic. Notionally, splitting the business into insurance and asset management operations, and monitoring each separately, is one way to achieve this.

    • Don’t rely on “the big one” to push prices upwards. The spectacular insured loss should not be used as an excuse to raise prices in unrelated lines of business. Regulators, rating agencies, and analysts – not to mention insurance buyers – are increasingly resisting such behaviour.

    • Redeploy capital from lines where margins are unsustainable. There is little that individual insurers can do to alter overall supply-and-demand conditions. But insurers can set up internal monitoring systems to ensure that they scale back in lines in which margins have become unsustainable and migrate to other lines.

    • Get smarter with underwriter and manager incentives. Incentives for key staff should be structured to reward efficient deployment of capital, linking such rewards to target shareholder returns rather then volume growth.