Think back to 1978. Pete Rose of the Cincinnati Reds had his 3,000th major league hit. The first test tube baby was born. Poland's Karol Wojtyla became Pope John Paul II. Nearly 1,000 people committed suicide in Jonestown, Guyana. And Egypt and Israel signed the Camp David peace accord.In the same year, the P&C industry made its last profit from underwriting for 25 years. That's right: Not until last year did the industry's combined ratio again fall below 100-which means for more than two decades, P&C losses exceeded premium earnings (see "P&C Combined Ratio," page 21).

After several years of tightening their underwriting standards to more carefully scrutinize and price risk, in 2004 carriers actually profited on premium dollars. They did this, in part, because they had returned to underwriting discipline. They knew they couldn't count on their investment earnings, which had fallen along with the stock market.

Now that the insurance market has softened again, the big question is: Can carriers remain so scrutinizing in their underwriting practices? Or, will they opt for growth, loosen their standards, and lower rates-as they've done in the past?

Some insurance companies will cut rates, but others-specifically the "sophisticated pricers"-won't have to resort those old practices, according to Fred Cripe, group vice president, product operations, at Allstate Insurance Co. They'll be able to stick to their underwriting principles and still find "sweet spots" in the market, he says.

"If this were 10 years ago, we'd already see full-fledged rate-cutting by most large carriers. But today, in part, because some companies are sophisticated at pricing-and understand the structures of the risk they're writing-there's plenty of high-quality profitable business to be acquired. So even in the face of increased competitive pressures, they don't have to resort to wholesale rate-cutting," he says.

Carriers are paying attention to the "Progressive Insurance" model of segmental pricing," says Gail McGiffin, global partner in underwriting solutions for the financial services solutions group at Bermuda-based Accenture.

"There's the desire to do a better job of mining customer data, of building more predictive and more granular rules, and of leveraging that feedback to continue to refine those rules," she says.

Saved by tiered pricing

Progressive Insurance Co., Mayfield Village, Ohio, declined to talk about its underwriting strategy. But Allstate agreed.

The Northbrook, Ill.-based carrier is also known for its sophisticated rating system-based on advanced data analytics-which it implemented in 1999. Allstate now uses this "strategic risk management" approach to underwriting for auto, homeowners and specialty lines including boats, mobile homes and motorcycle policies.

The system enables the carrier to place policies in a multitude of tiers rather than using a "flat" rating structure.

"The P&C industry has competed on price segmentation since the 1950s," says Cripe. "Back then, companies such as Allstate and State Farm took market share away from East Coast writers primarily by introducing then-radical writing variables, such as territory and driver classification," he explains.

Those rating variables didn't change much until the end of the century, when the industry moved to tiered pricing for personal lines.

"It was a gradual change to build rating structures that match price to expected costs," says Cripe. "It's about using data that's available about customers to more accurately match what we charge them to the expected losses and expenses they're going to have."

Using external customer data, such as credit records, motor vehicle department records and home ownership information, along with the information a carrier collects in its own databases, companies such as Allstate are able to perform advanced analytics to segment customers into hundreds of tiers.

"Primarily, this enables us to give better prices to customers that have lower costs and lower expected losses, and who in general have demonstrated a greater likelihood to renew with us and a greater propensity to buy other lines of insurance with us," says Cripe.

As a result, even in the soft market, Allstate is less vulnerable to losing any significant market share due to rate-cutting by its competitors, he says.

"Let's say we are competing against a large company that doesn't have a sophisticated rating plan," Cripe explains. "They're still using a flat pricing structure. And let's say, in Illinois, our prices are 20% lower than theirs for the high life-time value segment of customers-and our prices are 20% higher than theirs for the higher cost segment of the market."

If that company takes a 5% rate decrease, Allstate's prices are now 15% below the other company's for the high life-time value customers. Therefore, Allstate will still likely close those sales, he says.

And, for the lower life-time value segment, where Allstate's prices were 20% above their competitor's before, they are now 25% above those prices. "And that isn't going to change the amount of business we write in that segment significantly either," he adds.

It's only in that middle life-time value segment, where Allstate's prices may be in the same range as its competitors, that the carrier may lose some market share. "So their rate cut affects only a smaller segment of our business."

Focus on growth

At the height of the hard market, carriers focused on underwriting fundamentals and bringing structure and discipline to the underwriting process for more predictable underwriting results, notes Accenture's McGiffin. And they were successful-as the industry's 2004 combined ratio proves.

"But that has evolved now," she says. "The soft market has arrived. And now we're hearing about the need to sustain and build upon those profitable results from the hard market, while at the same time, increase the focus on growth."

The Citizens and Hanover Insurance Cos. is a case in point. Although the Worcester, Mass.-based companies' combined P&C ratio didn't fall below 100 in 2004, it has improved significantly-dropping from 106.1% in 2001 to 100.9% last year. And the companies' earnings in each quarter of 2004 surpassed comparable periods of 2003, even with a $40 million increase in net catastrophic losses sustained in 2004.

And Citizens and Han-over are now committed to growth-by expanding their appetite in the small and first-tier middle commercial markets, as well as in its specialty commercial lines, including marine, bond and umbrella.

"We are going to maintain discipline," says Richard (Dick) Lavey, vice president, operations and strategic initiatives. "We're not planning to compete solely on the basis of price, but on other distinguishing factors such as quality service and responsiveness to agents."

Instead of rate-cutting, the insurers will rely on a new commercial lines underwriting system to help implement a new operating model designed to foster growth.

The system is called CAAMS (customer account and activity management system), and in only six months of measuring its results, underwriting productivity has improved by approximately 25%, says Lavey.

Last year, Citizens and Hanover consolidated all their commercial customer and account data from five policy administration systems onto CAAMS. And this year, the companies are enhancing workflow through the system to enable underwriters to get out into the field to visit with agents at least two to three times per week.

"CAAMS is about getting our underwriters out there, driving new business in the door," says Erin Fenlon, director of technology for Citizens' and Hanover's commercial lines operations.

"So now we've been focusing on building structures within CAAMS to recognize which policies need to go to which underwriters-or group of underwriters-automatically."

In addition, she says, since the companies want to use the system to free up the underwriters so they can focus on their core responsibilities, they are also integrating other functions into CAAMS-such as ordering loss control surveys and accessing documents in the company's imaging system. It's the beginning of creating a "one-stop-shopping" underwriting workstation, says Fenlon.

A critical enabler

Indeed, just as technology enabled carriers to scrutinize risk more carefully during the hard market, it will also help them grow in the soft market, according to industry sources.

"We view CAAMS as a critical enabler to our commercial lines strategy," says Citizens' and Hanover's Lavey. "Our goal is to enable our front-line commercial lines underwriters to be out with agents more frequently, solving problems locally with those agents. We want our underwriters to have local knowledge about the industries and the customers in those markets."

Most importantly, management wants the companies' underwriters to be responsive to agents.

"In the markets were going after-especially that first-tier middle market-being responsive to agents is going to be a distinguishing characteristic," Lavey says.

As personal and smaller commercial carriers continue to invest in decision automation and predictive modeling for underwriting, larger commercial and specialty lines carriers are beginning to see how they can benefit from technologies previously thought to be inappropriate for supporting more complex risk, says Accenture's McGiffin.

Decision support technology-vs. decision automation-can bring structure and discipline to underwriting those lines as well, she says.

For instance, Fireman's Fund Insur-ance Co. is implementing Accenture's underwriting software to develop an enterprise underwriting platform, which includes a new component called "dynamic risk assessment."

Dynamic risk assessment provides decision support to the more complex underwriting process required for larger commercial and specialty lines, notes McGiffin. It guides the underwriter through the questions they need to ask and the information they need to gather, leading them to conclusions about how they should price the risk and what terms and conditions they should apply to a policy, she explains.

This is an important development, says McGiffin, because it proves that technology can be used to support underwriting decisions that insurers previously thought were "more art than science."

"Decision support technology doesn't take the decision away from the underwriters; it simply guiding them to better decisions," she says.

And with regulations such as Sarbanes-Oxley, and greater accountability for communications and decision-making (á lá Eliot Spitzer), insurance companies need to be more consistent and disciplined, she notes.

"Gastrointestinal underwriting is no longer accepted."

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