The Risks of Hazard

While reading Gallagher’s CEO first quarter synopsis (Best’s, subscription required) I was interested by his thoughts on the flat rate market in property insurance:

"I've never lived this way before," he said. "It's either one way or the other, where you've got rates coming down substantially and you're shopping everything, or rates are going up and you're scrambling to get the coverage you want."

He continues by describing how comfortable he is in such an environment because his company is built for competition: “Give us a stable rate environment and … we will drive organic growth."

As you may recall, a few weeks ago I mentioned I was planning a trip to Asia to try and find out how insurers, brokers, and reinsurers are handling their risk assessment, particularly for flood risk.

As I sit on the flight from Hong Kong to San Francisco, I have the memories from my 10-day Asia Risk Tour still fresh in my mind. Foremost are the warm welcomes we received everywhere we went, with immaculate hospitality from all our hosts. The food is also still vivid in my mind, from the Under Bridge Spicy Crab in Hong Kong to the famous street food stalls of Singapore, filled with sate and spicy seafood. Coffees and cocktails were enjoyed both under the ground and hundreds of feet in the sky.

I also learned a lot about how the insurance market in Asia manages location-specific risks, especially from natural catastrophes (nat cat), which of course is what I was there to do.

Underwriting property insurance is a very complex operation, with limitless variety on methods of management. I tend to concentrate on the risk associated with natural catastrophes damaging a location, but that is actually just a small part of the overall process. How an underwriter receives requests for quotes, builds quotes, and sends them out (not to mention how that quote affects a book’s accumulation) is an intricate process. What is so interesting to me is how software solutions are solving the inherent problems associated with underwriting as a whole.

Next week I will be heading to Asia to try and find out how insurers, brokers, and reinsurers are handling their risk assessment, particularly for flood risk. Asia is an exciting market for property insurers, with economies growing quickly and property values becoming valuable enough to stimulate thriving markets for insurance — especially for natural catastrophe coverages. It is also a breeding ground for innovation right now, as everyone is working hard to ensure they have the necessary tools to understand risk from all natural catastrophes (and Asia gets them all!). This article by James Nash (of Guy Carpenter) summarizes the situation in Asia and their response to it very well.

While researching underwriting leakage for an earlier blog post, I discovered another, more prominent type of leakage in insurance: claims leakage. While these two concepts are similar in nature, there is a fundamental difference between them that is worth exploring.

What is the difference between claims leakage and underwriting leakage?

• Underwriting leakage is the gap between optimal and actual underwriting (selection, pricing, and conditions).
• Claims leakage is the gap between optimal and actual settlement of a claim (payment of the claim according to the policy, correctly offsetting the loss).

Put another way: Underwriting leakage is a result of the inability to predict the future, while claims leakage is a result of the inability to accurately assess the past. Leakage is a fundamental concept for insurers because the insurance business is comprised of certain costs and assets balanced with uncertain liabilities. No other non-speculative business is so dependent upon an ability to know the unknowable.