Most insurers and reinsurers espouse a belief that new business doesn't always equal good business. To most insurance providers, the honeymoon period with a new customer ends as soon as claims activity intensifies.
Carriers know that when generating new business, discerning between a good and bad risk is difficult without thorough underwriting. The best underwriting units pride themselves on identifying not only obvious risk, but latent risk-lurking beneath the surface. Dynamic underwriting-through exhaustive fact-finding and critical data disclosure techniques assures that coverage is accurately priced to cover future losses.
Over the last few years, however, underwriting divisions within many carrier operations saw two developments confound their best intentions: The emphasis by carriers to stimulate market share through new-business programs, and the growth of the Internet as a distribution channel.
"The lack of efficiency in best-practices underwriting dates back to the late 1990s," says Lisa Powers, product manager, commercial manufacturing services, for Schaumburg, Ill.-based Zurich North America. "This occurred at a time when the market was extremely hard, and with a hard market, carriers commonly put business on their books to generate premium dollars with less regard for profit. With today's soft market, that's not a smart strategy."
With volume a priority and the Web helping drive distribution, underwriting was profoundly affected. Business on the Web demands speed-and most insurers agree that when it comes to assessing risk, underwriting is a process that can't be rushed. "There has been a lot of pressure on speeding the underwriting process, particularly with Web sales and point-of-sale trends," says Tracy Choka, senior vice president and director of the underwriting research and development team at Armonk, N.Y-based Swiss Re Life & Health, America Inc.
When life and health insurance programs are offered on the Web, there's a great deal of pressure to reduce cycle time for obtaining results for echocardiograms, treadmill and blood testing, and attending physician statements. Insurers are trying to push this process through quickly, which goes against the grain of optimal underwriting, says Choka.
But through the implementation of knowledge management tools, insurers and reinsurers are able to get the best of both worlds. A knowledge management platform-often equipped as an Internet- or intranet-based interface powered by software-enables underwriting units to make smarter business decisions faster.
"Using real-time actionable analytics with rules-based decisioning produces measurable results," says Mark Gorman, director, solutions market management, insurance, at Fair, Isaac and Co. Inc., San Rafael, Calif.
"That's really what the future is in our business-the ability to deliver that information in a way that allows you to make better decisions now with real-time information."
The timing is crucial. With insurers' earnings going south, underwriting is viewed as the key to return insurers to profitability.
"The industry has to bring a more disciplined approach to underwriting," adds Gorman. "In a hard market, solutions are now required that can bring consistency, predictability and performance. Knowledge-based solutions can begin to help, but they don't go far enough. You have to develop a solution designed with historical and empirical data as drivers."
In the late 1990s, as insurers' investment portfolios grew during the capital market boom, net income flourished. But with investment income dropping precipitously, insurers need strong underwriting more than ever.
This comes on the heels of a 2001 fiscal year that saw the property/casualty industry record its first-ever net loss after taxes. This performance stemmed from sharply higher underwriting losses and substantial deterioration in investment results, according to Insurance Services Office Inc. (ISO), Jersey City, N.J.
P&C insurers lost $7.9 billion in 2001-a dramatic plummet after earning $20.6 billion in 2000, according to ISO.
Compounding the effects of sharply higher underwriting losses, the industry's net investment income dropped a record 8.9% last year to $37.1 billion, ISO reports. Insurers' realized capital gains on investments fell 57.5% to $6.9 billion. In addition, insurers suffered $17.7 billion in unrealized capital losses not included in income.
Indeed, everything from the tragic events of September 11 to the escalating number of catastrophic claims relating to flooding, asbestos, mold and violent storms all served to waylay insurers and reinsurers last year.
In July, Hartford Financial Services Group said that in order to counter these events, it would shift $600 million in reserves in the second quarter to reflect emerging trends in asbestos and environmental claims.
However, many insurers, particularly small to mid-sized ones, lack the ability to shift reserves in such a manner.
And, if the havoc Mother Nature has wreaked isn't enough, insurers must contend with another factor. When it comes to writing commercial insurance, applicants are sometimes less than forthcoming-even dishonest-in disclosing critical information about their businesses. These practices were magnified in the wake of the Enron and WorldCom scandals, where unscrupulous accounting and lack of disclosure produced a trickle-down disaster. Poor accounting practices by a client prevents insurers from fully capturing the breadth and depth of risk, thereby increasing their exposure.
In short, insurers and reinsurers must cope with much external strife as they chart a course for growth. Now, through the implementation of knowledge management tools, carriers are proceeding with confidence about when to accept new business, reject it or reconfigure it.
These tools are also enabling users to drill down and pinpoint risk so precisely that they're proving to be excellent new-product development tools as well.
"We have developed what we refer to as 'institutional memory,' which any underwriter within our strategic business units can access to fit their needs," says Richard Cantor, knowledge management unit leader, The Chubb Group of Cos., Warren, N.J. "Sharing knowledge and fostering a shared corporate intellect is what we're striving for."
Implemented across the global reinsurer's three strategic business units-personal, commercial and specialty insurance-the program, aptly named "Lessons Learned" since it encapsulates Chubb's risk management experiences gleaned over many decades, was launched last year with the blessing of senior management and the support of third-party knowledge management solution providers.
Lessons Learned is a Web-based solution that consists of a large number of intranet sites, all dedicated to knowledge-sharing collaboration across Chubb's three business units.
For instance, within Chubb's commercial unit alone are 43 independent intranet sites, which are all unique in the data they provide various users. Through the success of Lessons Learned, Chubb is able to make quicker decisions on whether to accept, reject or perform additional research on potential new business.
Cantor stresses technology is just one driver of knowledge management initiatives. Making it work requires having the entire enterprise buy into the idea.
For instance, Chubb strongly believes that corporate IT departments should regularly share information with risk managers and insurers regarding attacks on corporate Web sites and computer networks.
Without knowing the full extent and nature of a cyber attack, an insurer can't develop products that are essential to helping protect businesses from the potentially significant operational and financial consequences of a wide-scale or targeted attack.
The larger body of information about such risk enables insurers such as Chubb to develop the actuarial tables to price products that provide substantial cyber risk protection. By passing along security-related information to risk managers, IT managers can help speed up insurers' product development efforts. According to Chubb, the development of cyber insurance products has been undermined by a lack of compelling cyber loss data.
Sharing is good
Chubb's initiative is a big step forward because it's interactive: It enlists the corporate client to help mitigate risk and calls on those across the enterprise to share data. Thus far, this has been problematic.
In a report released in July, New York-based PricewaterhouseCoopers (PwC) Consulting (which was acquired by IBM Corp. in late July) revealed that underwriting at many carrier operations exists within a silo mentality, with very little sharing of information among underwriters across product lines.
"There can be a tendency for risk to be concentrated into stand-alone silos," says Juan Pujadas, leader of the global financial risk management practice at PwC. "A comprehensive and integrated view of risk and a dynamic process for managing risk are essential components of a leading-edge risk management capability," he says.
In an environment where "risks permeate every aspect of the enterprise and where low probability, high impact events are grabbing headlines with increasing regularity, ignoring them is not an option," Pujadas adds.
PwC notes that progressive insurers and reinsurers are on the leading edge of "scenario planning," which means that all possible developments are factored into decision-making, and that a carrier knows how to react to evolving situations and when to reject projects that could lead to disaster.
Following the September 11 terrorist attacks, reinsurers discovered the individual risk they had underwritten proved bearable on their business, but they had lost sight of inter-linked risks that fell under the category of business interruption.
In PwC's report, Swiss Re was among several reinsurers that absorbed a heavy hit resulting from the attacks. Like many insurers, Swiss Re reviewed its risks after the attack and discovered that it was dangerously vulnerable to business interruption (B.I.) claims if a series of possible, if unlikely, events occurred. Swiss Re's experience proved insurers must take a step back from immediate risks, and review inter-linked and worse-case scenarios regularly.
But factoring all possible developments into decision-making through a process of scenario planning involves more than taking a step back. It also involves taking a step forward with regard to corporate mentality.
The Chubb Group's success with Lessons Learned came to fruition after it embraced the idea of knowledge sharing across the enterprise.
Exhibiting its commitment to this concept, Zurich launched in early 2001 a dedicated manufacturing services group to collaborate with business units within the operation. The goal: develop client programs around highly effective underwriting decisions.
Business interruption exposure was magnified after the events of September 11, but Zurich understood that B.I. exposure had been an ongoing dilemma.
To answer the problem, the global reinsurer developed a business interruption calculator (see article, page 22), which not only better assesses risk to price commercial coverage, but also supports contingency planning so a customer can interactively help its own cause.
It does this first by conducting a top-to-bottom audit of its revenue valuations; then, with valuations established, a commercial customer works with Zurich to develop a plan that enables it to get back in business quicker. Such a procedure is good for the business and good for Zurich.
All in all, each line of insurance comes equipped with its own set of risk circumstances. While B.I. exposure is a more specialized risk to capture, life insurers are making efforts to get a better grip on mortality trend lines. Swiss Re is among these eager carriers.
Following its December 2001 acquisition of the reinsurance operation of Philadelphia-based Lincoln National Corp., Swiss Re gained access to a tool-developed years previously by Lincoln Re-which is helping the company assess mortality risk and model life insurance products.
The Life Mortality System (LMS) is a patented, PC-based business process used for accumulating knowledge on mortality. Taking into account multiple risk factors such as an individual's age, health history and various other demographics, Swiss Re has been able to improve its assessment of mortality.
"Our corporate culture has embraced knowledge management for years, and we have dedicated R&D capital to developing a tangible knowledge management program to better understand and maintain our mortality benchmarks," says Swiss Re's Choka, who helped Lincoln Re develop and maintain the solution in the mid-1990s.
The process, which is used internally by Swiss Re and externally by many of its insurer clients, goes beyond technology.
dial in an assumption
The system draws upon a database containing more than 80 years of research from epidemiologists and other medical researchers, to crystallize mortality risk. LMS is periodically modified to furnish up-to-date information for mortality and pricing assumptions.
LMS is designed to enable an insurer to "dial in an assumption on mortality, change the underwriting parameters to fit their needs and tailor the system to fit their own individual markets," says Choka.
LMS was inspired by the need to develop life coverage for preferred and super-preferred clients. Modeling products such as LMS had been fueled for years by clinical research and empirical data to determine rating. But actuarial tables never existed to shed better light on this risk, Choka says.
Through LMS and the development of parameters governing this preferred group, Swiss Re enables its insurer-clients to develop a host of new life and annuity products. Swiss Re estimates that between 1997 and 2000, one-quarter to one-third of its new reinsurance premiums were driven by the solution's ability to assist insurers develop products or reconfigure existing ones.
LMS also is used by Swiss Re personnel to weigh the company's own risk position when determining to accept or reject reinsurance treaties from its insurer customers. If mortality data stacks up negatively through deployment of LMS, "we can walk away from the business fairly easily," Choka says. Without the system, Swiss Re may have been inclined to accept a particular treaty.
Rush to judgment
Successful implementation of knowledge management and decisioning tools begins the same way other insurance technologies are launched-via legacy system integration. The key element is the development of a data warehouse.
When Omaha, Neb.-based Empire Fire & Marine, a member of the Zurich Financial Services Group, explored ways to optimize both its risk-management and capital-management positions, the first step was to design a data warehouse.
In the past, Empire-which specializes in commercial auto with a focus on long-haul trucking and the rental vehicle business-relied on desktop applications or spreadsheets with limited data sets. This limited Empire's ability to accurately evaluate critical metrics.
"The key was to get our various databases to communicate with one another," says Deanna Crist, assistant actuary for Empire Fire & Marine. "We performed a data cleansing and-all in all-it was a fairly painless process that took about six months."
With a dynamic data warehouse to support the effort, the next step was to identify a solution that would mitigate risk, improve capital management and realize significant savings on reinsurance premiums. Empire found the solution through Purchase, N.Y.-based DFA Capital Management Inc.
In April 2000, after the data warehousing project to link its various databases was complete, Empire began a pilot project to develop and test the DFA software. The DFA solution features advanced analytics that distill raw simulation output down to dynamic metrics and graphical displays that directly address important issues.
The result: Empire Fire & Marine was able to confidently assess its risk position in a number of areas. Without the DFA solution, Empire had been vulnerable to a spate of inaccurate pricing on reinsurance treaties.
But recently, when the company explored a reinsurance treaty to take on a percentage of risk regarding a crop insurance policy in conjunction with Cincinnati-based Great American Insurance Co., it did so with full confidence.
Crop insurance is often a government-sponsored program, which adds to the complexity, says Steve Rand, CEO of Empire Fire & Marine. "We ran a series of scenarios and 'what-ifs' using the solution and the outcome was positive," he says. "In the past, these what-if scenarios were done through guesswork by an underwriter. Now we have access to more precise probability."
At Chubb, the Lessons Learned database also has enabled underwriters to make confident decisions on whether to accept, reject or perform more research on potential new business.
"We reviewed a new business prospect where the client was a venture capital group that had ownership in the mining business," says Cantor. "Without the database, that underwriter would probably have had to embark on a series of internal referrals with underwriting managers to build a case for or against the new business.
"Instead, the underwriter used the system, which is highly searchable, to extract very detailed data and then draw a confident conclusion about that particular risk," he says.
As insurers proceed in the development of risk management initiatives, industry observers point to several keys. A holistic approach to risk management is obviously necessary.
However, insurers also must perceive risk management not simply as an avoidance of loss, but more importantly, as a way to increase shareholder value, according to Jeremy Scott, global head of financial services for PwC. Adopting this philosophy is essential to creating a world-class risk management culture, he says.
The technology component of these initiatives is actually the easier part. "The difficult part is the corporate culture piece of knowledge sharing," says Chubb's Cantor. "For years, our underwriters have shared information in casual conversation around the water cooler. They still do, but now they have a technology piece added to the mix."
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