Profitability trumps growth, right? Indeed, after declining for six straight years, average property and casualty rates have been on the rise since late 2011, according to MarketScout Corporation's research. The traditional approach to increasing loss costs and improving market conditions is for P&C carriers to raise rates across their book of business—even if that makes them less competitive.
But what if carriers could be more sophisticated and selective about rate increases in a hardening market—thereby retaining a competitive edge? Moreover, what if there are serious pitfalls to your traditional approach of across-the-board rate increases? Aaron Mayfield, director of commercial solutions for Marshall & Swift/Boeckh (MSB), proposes an alternative approach that balances rate increases with insurance-to-value (ITV) initiatives.
“In a hardening market, insurance carriers should move beyond ensuring 'rate adequacy' and actually assess their 'premium adequacy,'” Mayfield explained during a recent PropertyCasualty360 web seminar on “Insurance-to-Value: Optimizing your underwriting strategy and rate sophistication in a changing commercial market.” Instead of uniformly increasing rates, he said, “Carriers should balance rate increases with more proactive management of the insurance-to-value baseline in their books of commercial business.”
Mayfield cited a number of pitfalls to traditional across-the-board rate increases. First, he pointed out, book of business ITV is inadequate to maximum possible loss (MPL). Increasing rates also increases rate subsidization—and the likelihood of adverse selection. And—no surprise—newly developed rates reduce carriers' ability to compete for new business in the marketplace.
Moreover, MSB has extensive data showing that base rates developed with historical loss indicators do not fully account for hidden undervaluation exposure. The firm's annual ITV index, for instance, reveals that 30 percent of buildings are undervalued by 50 percent—and fully 50 percent of contents are unvalued by 50 percent.
Optimize the Opportunity
In contrast to these pitfalls, Mayfield's presentation emphasized four key benefits of a more balanced approach—what he called “optimizing the opportunity” in a hardening market:
- Book of business ITV is adequate to cover MPL–ensuring proper premium and rate coverage for catastrophic as well as large partial losses.
- Premium increases are aligned to exposure, and therefore may not require rate adjustments.
- Premium deficiency and rate subsidization is addressed and adverse selection is minimized.
- Addressing premium deficiency better aligns changes to rate and makes you more competitive for the new business coming to market.
Mayfield's presentation delved into the impact of undervaluation, pointing out that while broad rate increases do generate increased premium, they don't target premium deficiency. Moreover, modifying rates to account for increased losses still fails to address ITV. Focused ITV initiatives identify premium deficiency within the current rate structure to help recover premium while ensuring each risk is being evaluated equally. As a result, rates are only adjusted when premium is deficient according to predicted loss models.
Balanced Return on Investment
The potential return on investment (ROI) for this balanced approach is compelling. Mayfield provided an example compared an ITV baseline the return made possible by when ITV initiatives are deployed. With $500 million in total commercial non-liability premium and 100,000 policies, the baseline example resulted in 57 percent undervalued contents and 65 percent undervalued building coverage, with an average policy premium of $4,750 and average policy coverage of $2 million. Deploying a balanced approach, with both rate increases and ITV initiatives, average policy premiums increase to $5,000, coverage expands to $2.25 million, and commercial coverage opportunity reaches $33.75 billion. The resulting premium opportunity: $67.5 million.
Mayfield also pointed out other benefits to the balanced approach.
“MSB has indications from all major catastrophe models that undervalued input can have a nearly dollar-for-dollar effect on modeled loss outputs,” he explained. Using the balanced approach and employing MSB's book-of-business valuation can reduce rates 10 to 15 percent, making them dramatically more competitive. A more competitive rating structure retains existing insureds and increases new business—including increasing capacity to take on new profitable business opportunities. Finally, he said, “You can ensure your book is aligned to your underwriting strategy.”
Getting Started
To get started with ITV initiatives, insurance carriers often have to overcome the perception that “my book is fine”—as well as resistance to change and concerns about implementation time for the balanced approach. The first step to take is to develop the correct TIV baseline for the entire book of business and base rates.
“New business should be written at the correct TIV and ITV,” Mayfield said. “Renewal business should be shifted to TIV with a new rating structure. This way, carriers can focus rate increases by correcting ITV and addressing premium deficiencies.”
View the web seminar here.
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