1. Insurance Premium Risk, Competition and the Insurance Cycle George Maher

2. The pig cycle

3. Underwriting Cycle UK and Irish motor business Loss ratio = Claims/Premiums, excluding expenses

4. Causes of the cycle – common theories  Macro-economic cycles – less demand and a higher propensity to claim in depressed economic conditions  Investment volatility – cash flow underwriting to pursue investment returns  Loss shocks – major events causing movements in prices  Reserve smoothing – reserving more conservative when times are good, may increase the amplitude of the cycle  Underwriting management – premium volumes versus profitability issues exacerbated by lags in obtaining good management information  Fear of exclusion – writing business in soft markets so don’t miss out in hard markets and fixed expenses

5. Insurance Risk: Underwriting  The underwriting cycle is a well documented feature of the insurance industry  About 7 years on average  Wide fluctuations in profitability  Strategies vary  profit from volumes at good prices  accept price / protect brand  Linked to business and interest rate cycle  How much can the loss ratio vary from year to year?  random fluctuations  pricing error  underwriting cycle

6. Insurance Risk: Underwriting (2)  Consider in relation to the insurance cycle whether new business will  Create capital strain  Generate profits  Meet business plans with the existing capital

7. Insurance Risk: Modelling  Features of the underwriting cycle can be captured in the ICA modelling of loss ratios.  Aggregate loss ratio for attritional claims  Appropriate statistical loss distributions  Cycle introduced via stochastic time series model  Loss ratio can be related to  Prior loss ratios  Long term average loss ratios  Random components  Other trends, such as claims inflation outstripping premium increases

8. Risks driven by the cycle  This suggests a number of other risks that could be related to the underwriting cycle possibly impacting an ICA  Economic environment  Correlating directly with loss ratios (e.g. creditor or MIG)  Propensity to claim  Fraud or negligence becoming more apparent in weak economic conditions  Operational risks  Optimism and belief gaps  Is the company writing unprofitable business?  Management information  Lags in true information on rate levels  Underwriting controls  Reserving risks  Reserve adequacy (reserving cycle) and financial statements  Underestimation of reserves is likely to have knock-on affects on pricing

9. Reserving Cycle - UK annual business Source: Kevin Wenzel; Institute of Actuaries Working Party

10. Approaching the cycle  Quantification of an explicit “cycle” risk is difficult  Understanding of the interdependencies in the business that both drive and react to the cycle will be key  Understanding the underwriting cycle is key to separately identifying the pricing risk from the claims risk components  What is the firms ability to withstand cyclical pressure  How does the firm manage the cycle  How realistic are the assessments of cycle as presented in management information  Underwriters assessment  Links to the reserve cycle  Changes in terms and conditions making it more difficult to quantify  Correlations of large shocks will be important but difficult to quantify  E.g. impact of a catastrophe on reinsurance costs

11. Questions  Will the underwriting cycle continue?  Does the cycle have capital implications?  How predictable is the cycle?  What drives the cycle?  How realistic are we (actuaries, management, underwriters) about the downward part of the cycle?  Do we control the cycle or just react?  How do we control it?  Do we know we are controlling the cycle? What does “we” mean?  Should control vs. react make a difference to the ICA?  If the company is managing the cycle how should it capture this in its ICA?  Can you really separate the pricing and the claims risk in the underwriting cycle?