Bring Out The Brooms: For Mutuals The Key To Success Lies In "Sweeping the Corners"
September 21, 2017| Von Rick Hartmann
P/C General Industry
Region: North America
For some, legacies are not important. For mutual companies, legacies matter. With the National Football League (NFL) season underway, I’m reminded of an anecdote that Herm Edwards, ESPN analyst and former NFL head coach, often used to illustrate the importance of leaving behind a positive legacy.
When Herm was eight years old, his father - a military man - handed him a broom and told him to sweep the backyard. He swept the yard, but as his father inspected it, he pointed out that his son forgot to sweep the corners. Herm responded, “Dad, nobody knows.”
His father’s rebuttal: “Son, you know.”1
In our most recent post, we discussed investment performance as a key driver of profi tability for mutual companies and how the persistence of low interest rates will continue to be a drag on earnings. In addition to dragging down results, depressed investment yields may likely influence underwriting and pricing behaviors for mutual companies.
A mutual company’s primary purpose is to provide value to its policyholders, in particular by growing policyholder surplus - the buffer against the underlying risk imbedded in its portfolio. As these companies work to maintain underwriting profitability, they too will need to “sweep the corners.” For a perspective on the industry’s underwriting performance, let’s take a look at the calendar year combined ratio for the P&C industry over the last 30 years.2
Historically, the industry has struggled to register an underwriting profit. However, from 2013 to 2015 the industry enjoyed three consecutive years of underwriting profits, which was the first time this trend occurred since 1971. In 2016 we witnessed a return to a more normal result, with the industry operating at an underwriting loss as high catastrophe losses led to deteriorating industry profits.3
In fact, U.S. Cat losses added almost 5% to the industry’s combined ratio in 2016, and the longer term trend is for more - not fewer - costly events. Successful mutual companies will proactively identify, map and manage peak accumulations. Specifically, they will rebalance their underwriting portfolios like an investment portfolio.
As if countering historic trends wasn’t enough of a challenge - mutual companies face significant headwinds in both the personal and commercial lines marketplace. In fact, A.M. Best is maintaining a negative outlook in the commercial lines sector due to a number of factors, including:
- Price competition
- Decreasing levels of favorable development of prior years’ loss reserves
- Return to normalized Cat losses
- Above average levels of non-Cat large losses
- Increasing frequency and severity in Commercial Auto
However, according to A.M. Best, the overall commercial lines' sector profitability remains strong. The mutual companies that are able to maintain consistent underwriting fundamentals and outselect their competition will be best positioned to successfully manage the challenging headwinds.
For personal lines, the competitive landscape is equally challenging - albeit A.M. Best is maintaining a stable outlook for the sector. The Personal lines writers best positioned for long term success will be those who have advanced pricing segmentation, a laser focus on rates and a strategy for managing the potential adverse impacts on written premium from autonomous vehicles.5
To produce an underwriting profit, mutual companies will need to maintain sound technical pricing and keep up with trend despite competitive pressures to reduce rates. Understanding that results are fragile and can quickly deteriorate, let’s examine the potential negative impact of getting behind on rate adequacy.
Let’s assume you start with a 95% combined ratio.
Hypothetically, due to competitive pressures in the marketplace, you renew your book without making any changes to your pricing, despite observing increased frequency or severity in your portfolio. If you assume a 2% increase in frequency and a 2% increase in severity in Year 1, your 95.0% combined ratio becomes a 97.7% at the end of Year 1; if you still do not take any corrective action, your result will become a 100.6% in Year 2 with all else being equal.
Now imagine if frequency and severity increased 4% each. Your 95.0% combined ratio could become a 106.5% in only two years.
Ultimately, keeping up with trend via rate is critical for mutual companies to produce profitable underwriting results and maintain the stability needed to grow policyholder surplus.
Is there a “secret sauce” to successfully produce profi table underwriting results despite the competitive headwinds?
Many believe data analytics and technology investments are the answer. To learn more about the role data analytics and digital technologies will play in transforming the traditional marketplace, be sure to read our next post. In the meantime, please feel free to reach out with any questions or to share your thoughts.
- Spencer Griffin. “Herm Edwards uses anecdotes to give advice,” The Echo, February 20, 2013.
- A.M. Best Aggregates & Averages, Insurance Information Institute.
- Lynch, James. “Property/Casualty 2017: An Overview of the Industry” (Presentation, Western States Surplus Lines Conference, Las Vegas, June 12, 2017.)
- “Commercial Lines Outlook Remains Negative as Market Conditions Become Increasingly Competitive Across the Segment,” Best’s Briefing, December 12, 2016.
- “Personal Lines Outlook Remains Stable Despite Continuing Pressure on Auto Results,” Best’s Briefing, December 12, 2016
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