Articles - Its testing time for carefully honed risk appetites

Risk carriers in international wholesale markets passed a crossroads with the catastrophe losses of 2017. During a dozen years without market-changing events, the market had travelled in a fairly uniform direction: down towards weak pricing and generous terms and conditions. During that time, other market dynamics – particularly capital supply, but also analytical capabilities – changed dramatically.

 By James Wackrow, Chief Actuary, Advent Underwriting Ltd.
 Meanwhile individual companies had the opportunity to get ready for the next market-changing event. Harvey, Irma, and Maria may not have transformed a relentlessly softening market into a classical hard one, but the trio of storms has changed the game in other ways. Risk carriers have (or should have) mapped out post-event action plans. The extent of their preparations will determine how well (or poorly) they perform, now that we are travelling the road on the other side.
 Some companies will have limited their decade of preparations to ensuring they are able to assess the cost of a big event, and possess the wherewithal to weather it. Now that it has happened, they will simply be waiting to see how the market responds. Any company so ill-prepared may be in for a shock. Given the sustained softening we have all endured during a dozen years of relative calm, even a 20% or greater rate hike may not return some lines and risks to profitability. However, other companies have spent their time identifying sweet spots, and relentlessly targeting them. After such advanced work, even a 5% rate hike in a narrow class may be an important development.
 This process continues constantly, as more data arrives, and more experience is garnered from previous events. Such ever-accumulating background allows carriers to continually refine their view of segmentation. Part of any underwriter’s skillset should be an intuitive ability to discern the good risks from the bad. Pricing actuaries’ role is to imitate that ability using data and analysis.
 Between them, they should have identified their sweet spots, and the areas to avoid. Ideally, they have worked together ceaselessly to improve pricing models and will continue to do so. In practice, the perfect model can never be created, since new data and experience will always modify their joint view, but any company that has been refining its models and risk appetite over the past 12 years should now be in a very strong position to know exactly where they wish to focus, in a turning post-loss market, to expand their underwriting.
 That is bound to take some time. At present, most insurers are focussed primarily on making an adequate amount of money. When rates improve sufficiently, the game will have changed, subtly, to optimising return on capital. Well-prepared insurers will make active choices about deploying their limited capital, choosing what to write and what to decline based on a highly-refined risk appetite supported by well-honed models. Those that have defined and refined over the past 12 years will know best how they wish to write business to optimise return vs risk, and will begin to reap the benefits.
 Much has changed since the events of 2001 and 2005, the most recent years with arguably comparable loss events. One important facilitating development for carriers operating in the Lloyd’s market has been the new speed with which Lloyd’s accepts, reviews, and approves changes to syndicate business plans. This process had been sluggish, but has improved dramatically, which is critical for managing agents that adopt a dynamic, constantly evolving approach to defining their risk appetite. Centrally, Lloyd’s is now much more responsive to requests for amendments, and much more sensitive to market changes.
 The desire to change focus, and Lloyd’s ability to accept that desire, is a dramatic change from 2001, when the World Trade Centre event moved the market. Immediately post 9/11, many insurers in effect simply battened down the hatches until the overall impact of the loss emerged clearly. Since then, all carriers have acquired capital and catastrophe modelling tools, and have assessed all the eventualities repeatedly. They have had plenty of time to determine how large losses would impact upon them, and to get ready for the day when they arrive. The upshot? Unlike the World Trade Centre, the 2017 hurricanes, in aggregate, were not a big surprise.
 The market has been on the front foot, after anticipating this event for several years, and preparing focussed responses. Lloyd’s regulators are much better prepared as well. Everyone has modelled the impact of a single-quarter market loss of US$100 billion, which is why it has not been world-changing. It is within our risk appetites, and already we are back to business as usual.
 That said, there are always lessons to be learned and we can all expect some surprises as 2017’s loss events mature. Flood losses from Harvey may still develop further, since flood has been only poorly modelled. Losses in the Caribbean may also suffer adverse development, since circumstances, including the sheer volume of claims, have made it difficult for adjusters to adequately assess claims costs. History tells us that big losses have a tendency to deteriorate over the first 18 months, but carriers that have done their homework to refine their models and their views of risk will have accounted for potential development in their initial reserve-setting exercises. For the most part, reserves posted at the end of September remained relatively stable at year end.
 Within a model, every loss is a standard loss, but in the real world each event is unique. Real storms tend not to match modelled tracks, as Maria and Harvey showed. The market has learned some specific lessons, too, such as the potential magnitude of business interruption risk faced by Caribbean hotels. We will now be returning to our models and methods, and revising them again, to further hone our individual risk appetites. Fortunately, the totality of the losses fell within our collective expectations, even if the details differed. With views of risk defined and refined over years, carriers should have been able to post reserves sufficient to meet adverse development, and are perhaps even hoping for modest future releases. Most importantly perhaps, if insurers are smart and have spent the last 12 years productively, they can make the most of what happens to the market now, even if it is not what they may have hoped would happen. The hurricanes of 2017 may not have changed the market into an old-style hard market (at least, not yet), but in this way, the market has changed, and won’t be changing back.

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