The World Is Always Changing–And Risk Along With It

Tell us about the challenges carriers are facing today at determining adequate rate. What short-term or long-term risk trends are driving this phenomenon?

The current risk environment presents the most significant challenge to confidence in rate adequacy that the industry has faced in 45 years. The industry is dealing with the combined impact of multiple factors, including a war in Europe, aftermath of the pandemic, social unrest, climate change and growing cyber risks.

On a macro level, economic inflation is clearly having a major impact. Social inflation has also been well documented. One important example is litigation funding. A third-party research firm recently conducted an analysis of the phenomenon, and the report was eye-opening. Litigation funding is driving more lawsuits. It’s driving up the cost of litigation, which contributes to larger verdicts. And it has a snowball effect where, with each win, there’s more capital created to provide a return to the investors and to fund the next suit.

The report suggested that in an effective third-party litigation finance model, every $1 billion these third parties are investing would result in $10 billion in industry losses. When you consider all this, along with the tightening of reinsurance capacity and alternative capital, it’s just imperative that carriers secure adequate rate now and in the longer term.

What should carriers prioritize when it comes to mitigating these challenges?

It’s important to take a prospective view of inflationary trends when establishing rates and underwriting risks. Terms and conditions are important as well—we need to be thoughtful when it comes to co-insurance clauses, margin clauses and valuations, among other things.

As to litigation funding, while there may not be much we can do directly to mitigate it, we need to be diligent in managing our line sizes for risks in industries that could be in the crosshairs. And as an industry, we need to do more to pressure legislators to shine a light on the practice and require more transparency during litigation to expose when funders are involved. It would be good to promote greater public recognition that, in the liability space, some of the biggest litigation funders are the plaintiffs’ attorneys themselves.

How can carriers work with brokers to help clients understand the need for rate adjustments?

Now more than ever, it’s critical that we help our brokers understand everything that goes into underwriting. Our brokers and the risk managers and other buyers of our products are sophisticated and thoughtful, so it’s important that we’re as transparent as we can be when it comes to our underwriting philosophy, as well as claims trends, so well-informed decisions can be made on how to transfer risk.

We’ve touched on rate adequacy, but how have the challenges you described affected risk scoring? Do carriers need to adapt risk scoring methods to current market conditions?

The challenges we’ve described have impacted underwriting. One response to these challenges is seeking to better evaluate risk, and risk scoring helps with that process. We have to constantly reevaluate our assumptions: characteristics such as industry classification codes, which have historically been reliable indicators of loss costs, aren’t necessarily as reliable today. To combat changing market conditions, we have to better understand potential risks.

We’re scoring policies using a multivariate methodology to more precisely underwrite and price the risk. It’s an important part of our underwriting process, particularly in the small-business segment, as it can be automated and the predictive analytics are delivered to our underwriters before they look at the submission—and in some cases even delivered to our producers prior to the producer marketing the account. Not only has policy scoring helped us avoid risks that we believe would be detrimental to our portfolio, but the associated technology and the data sharing also provide a favorable user experience for our partners. And it ties back into what we were saying about being transparent, sharing what we’re learning about the changing risk environment with our producers.

Carriers and brokers have this wealth of data to help them understand how risks have changed, but it can be difficult to make use of this data because it is decentralized or hard to access. What do you think the industry should prioritize when it comes to making use of that data?

We could benefit from a more standardized industry approach related to basic data. Most of the loss data in our industry is confidential to the individual company, and there isn’t a lot of publicly available data, given that settlements and claim resolutions are confidential.

This gives larger, longer-running companies an incredible edge if they can harness the years of loss data that they themselves have. In the case of a company like Markel, you can learn a lot looking at over 40 years of underwriting data, whereas a startup is going to have a harder time, since they’re starting fresh and only have data that might be publicly available. There have been some examples of this in the insurtech space, where companies have had incredible technology but the lack of reliable data has impacted their ability to price risks and drive profit.

What kinds of technological tools can carriers and brokers implement to promote efficiency and make better use of their data?

We talked about using third-party data to score risk. Leveraging AI has great potential to enhance the impact of the data and even to optimize underwriting. Risk-level information can be efficiently obtained using satellite images of roofs and using data to get the construction type of a building. That’s not new technology, but it is helpful.

Newer, more exciting technology helps in the insurance purchasing and risk mitigation process.

Traditionally, an insurance application provided a snapshot of a business, and the underwriter made an annual commitment based on what the exposure looked like at a certain point in time. But, for example, in the small-business space, a lot can change quickly. Is an insured company experiencing layoffs or entering a new market or something else? The idea is that, by leveraging third-party data, a carrier can see risk indicators in real time.

Using data on a continuous basis throughout the underwriting and policy lifecycle process can result in better decision-making. We see this a lot in the cyber insurance space—a business’s firewalls and protection might be up to date at the time the application is filled out, but again, that could look very different two weeks later. Technology that constantly scans those systems and looks for vulnerabilities can provide tremendous value to carriers and policyholders alike.

Do you think other methods of risk transfer can be used to offset higher claims costs for product lines like commercial property—such as the specialty market, parametric insurance, or anything similar?

The specialty and non-admitted marketplace is increasingly playing a major role as solution providers. Direct surplus lines premium written in 2021 grew 25% and represented over 20% of commercial P&C premium written. From 2016 to 2021, the E&S market grew more than three times the rate of the U.S. admitted market. The results over time suggest that specialty underwriters are best positioned to weather the storm of volatile market conditions—not surprising, given their freedoms of rate and form during the underwriting process.

There is also an opportunity to use alternative risk financing solutions like cat bonds and parametric products. The structure of the trigger in these solutions is particularly important.

And there’s usually some level of basis risk, which is the risk that the payment could be lower than the actual damages that a buyer has to pick up, which a traditional insurance policy might indemnify. An example would be a parametric product that covers losses from hurricanes but wouldn’t cover the loss from a tropical storm.

There are also benefits to parametric cover: adjusting losses and making payments to policyholders happens very quickly, and coverage is less likely to be litigated.

Do you think that government could have or even should have any involvement in managing these larger emerging risks? A Terrorism Risk Insurance Act (TRIA) for cyber risk, for example?

We saw the government step in in 2002 with TRIA, which was necessary at that time in order to stabilize the insurance market. I’m not sure if that would be an appropriate solution today for cyber risk, as there’s a pretty robust cyber insurance marketplace.

The creation of a government solution, which could require carriers to allocate capital, could also actually have an unintended impact on that robust cyber marketplace and potentially reduce the capacity that’s available in the market. And, as we touched on, there are likely opportunities to export or absorb cyber risk into the greater capital markets by involving insurance-linked securities.

My overall point is that the insurance industry needs to take a long-term view of these challenges. Carriers need to secure adequate rate to compensate for increased loss costs and the impact of inflation, as well as ongoing uncertainty and volatility. Our goal should be to make sure that we are there for our insureds in their eventual hour of need.