By TOM KING, senior director, and JAMES MULLARNEY, director, product strategy, Oracle Insurance, a division of the Oracle Corp., the Redwood Shores, Calif. database and software applications company
As a rule of thumb, one policy will never cripple an insurer, but a book of business can. With the recent turmoil in the financial markets, this adage has never been more relevant. Unlike the days of cash-flow underwriting, insurers today cannot rely on investment income revenue streams to ensure their overall profitability.
With the softening of the property/casualty market and slump in variable products in the Life segment, insurers are working hard to maintain revenue levels. The risk in this environment is that underwriting, pricing and rating discipline will slip to meet revenue targets. Under this scenario, when discipline declines, insurers are vulnerable to a severely negative claims tail that could put them at risk.
To remain profitable in the current environment, insurers must focus both on how underwriters manage their day-to-day underwriting activities and develop books of business. There is, however, a new twist to this challenge. The insurance and financial industry can expect significant new regulatory requirements as a direct result of the last year's events in the financial markets. These new regulations will likely require greater transparency as well as measures that indicate how individual line of business portfolios affect each other and the company overall.
Transparency and expanded insight are fundamental to managing risk across the organization--in the underwriting process, in portfolio development and even at the overarching corporate level. Insurers that focus on building new levels of visibility and insight into their processes will find themselves in a strong position to facilitate compliance with emerging regulations and adapt rapidly to changing business conditions both within the organization and beyond.
MANAGING OPERATIONAL RISK
Underwriters have budgets that they need to meet, as well as retention rates and other metrics against which they are measured. Profitability is a factor in the underwriter assessment and scoring process, but often, especially in long-tailed business, it is not the most important factor or will not be a meaningful measure for several years. In a soft market (P/C) or a market in which the public has turned distrustful (variable Life products), maintaining underwriting discipline is difficult.
For commodity markets, insurers have a much higher degree of control over underwriting practices. Most of the underwriting is baked into submission approval and pricing models that insurers are striving to automate. Where insurers find themselves at risk are in lines of business with a high level of underwriting involvement and significant flexibility in pricing and underwriting practices. How can insurers maintain a high level of institutional discipline and protect the top line, while giving underwriters the flexibility needed to compete in a tough environment?
A number of best practices should guide the industry and individual insurers in managing operational risk. These include:
Automating Task and Workflow Management
Each line of business dictates specific tasks and activities that insurers expect underwriters to perform. Insurers should leverage a workflow and task-based system that sets up the minimum standards with which underwriters are expected to comply. This could include information requirements for underwriting decisioning, such as loss runs or inspections, or rules-driven workflow/task generation that identifies specific steps the underwriter must complete. This approach enables the insurer to confirm that underwriters always perform certain functions consistently and that the data is available to review as books of business develop. Automating underwriting tasks also frees underwriters for more value-added activities. Further, automated workflow tasks can keep underwriters up to date with transaction status and policy/book information updates based upon company defined criteria.
Analysis Between Claims and Underwriting
Tying the claims experience back to the underwriting process can provide necessary insight in further defining underwriting and rating guidelines. Insurers can use an enterprise data warehouse and corresponding business intelligence analytics to easily analyze claims and underwriting processes. Underwriting-to-claims analytics provide insurers with the visibility needed to adjust underwriting rules, rating logic and product pricing to more accurately price risk per product.
In a volatile market, insurers need to know how to target customers.Most importantly, insurers must offer the right products, priced accurately for the risk. Customer relationship management (CRM) systems that offer a single view of the customer are essential to track customer relationships across an enterprise. Customer information residing in disparate systems limits overall visibility and the complete risk attributes of an insured account (not just a single policy) may not be as apparent. In addition to identifying issues, an enterprise CRM system can help uncover opportunities such as cross-selling and effective market segmentation in addition to identifying when an account may be lost to competition.
Visibility and the ability to take rapid action are fundamental to mitigating risk. As a first step, insurers must eliminate the paper underwriting file to provide visibility into how they are institutionalizing and developing underwriting discipline. As long as there is a paper underwriting file, management will never have a proactive view into the underwriting process. In these cases, management must rely on training and audits to ensure that underwriters are following company and regulatory procedures. The drive to cut costs from an organization often curtails training, leaving insurers with no guarantee that underwriters will follow established guidelines.
Underwriting audits are necessary to help refine the underwriting process, but are not an adequate tool for proactively uncovering problems, as they are conducted after the fact and generally only cover a sampling of files.
With an online, virtual underwriting file and self-documenting rating and underwriting system, insurers can execute more effective audits and uncover trends faster. Insurers can leverage the underwriting system and analytics to identify files or books of business that should be audited or reviewed. In addition, auditors no longer have to visit the underwriting office to review files since a virtual underwriting file can be accessed by authorized personnel anywhere; they no longer have to be in the office in which the underwriting file is stored.
Analytics are another important aspect of ensuring visibility and mitigating risk. By tracking trends in insurers' performance, analyzing success/failure from marketing campaigns and monitoring loss-ratio, insurers can identify new revenue opportunities as well as ways to reduce unnecessary costs and sources of risk.
Managing Book Risk
Most insurers face significant issues with speed to market and the ability to adjust products as experience develops. Insurers need real-time visibility into how premium and claims books are developing. This includes data that extends beyond premium and claims levels to include characteristics associated with the underlying policies and how an insurer measures which lines are priced/underwritten correctly.
Too often, companies rely on today's premium to rectify yesterday's pricing/underwriting mistakes. The process only can change with immediate insight into how books are developing and the tools (underwriting, rating, policy administration, billing, state filing and claims applications) that allow them to quickly change business models to react to emerging trends.
Access to data and the tools to interpret it are key requirements for gaining new levels of agility. This includes delivering data to the desktop of line and underwriting managers as well as making available product-specific tools such as geo-coded data and scenario-based tools that will enable management to determine the effects of proposed changes on business portfolios and profitability.
Insurers at the corporate risk level face the major challenge of correlating multiple books of business and identifying how they affect the company as a whole. For example, $100 of auto premium represents a much different risk to the insurer than $100 of professional liability premium.
Similarly, $100 of term life represents a different level of risk than $100 of whole life or $100 in annuity premium. Insurers need a holistic view of entire books and what they represent to the insurer as a whole. Does any one book, or several books, pose an inordinate risk of making the insurer insolvent? The assumption is that, if every book is underwritten correctly, reserved adequately, and backed up with appropriate reinsurance plans, then the insurer should remain solvent. As past events demonstrate, this assumption does not always hold true.
Moving forward, new regulations will almost certainly require insurers to have deeper insight into the type of business they are writing and how those books of business interact. This will require more detail on every book of business as well as the ability to compare how they accumulate risk for the organization. Insurers will likely also need to employ a greater degree of scenario planning with associated action plans that will be activated when certain parameters are met. This level of analysis and insight will also start to dictate not only the assumption of risk but the requirements for reinsurance programs and risk mitigation programs--mitigation programs that would be leveraged during both the underwriting and claims processes.
The dynamic market presents new levels of risk as well as heightened operational challenges for insurers. It can reveal new opportunities for insurers that have the insight and agility to move swiftly to capitalize on changing market conditions. Take action today by reviewing how your organization performs in managing operational risk compared to the industry's best practices. If you don't know, ask! Insurers that prioritize visibility and business insight in today's challenging market will find themselves well positioned to manage risk, ensure regulatory compliance and drive growth moving forward.
July 1, 2009
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