IFRS by ert554898

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									                Derek Bain
       Director of Actuarial Services
                AXA Ireland

          The Underwriting Cycle

IFRS

                        The Insurance Institute of
                                      2008
                         Ireland, Wednesday 26th
                              November 2008
                         Ballsbridge to Hotel
                        Rising Court the
                             Challenge
                         1st Annual CPD Conference 2008
                              Managing Claims Costs




             Motor underwriting performance 1977 - 2007


                           Motor Market Underwriting Cycle
 40%
 30%
 20%
 10%
  0%
-10%
-20%
-30%
-40%
   77

         79

               81

                     83

                           85

                                 87

                                       89

                                             91

                                                   93

                                                         95

                                                               97

                                                                     99

                                                                           01

                                                                                 03

                                                                                       05

                                                                                             07
 19

        19

              19

                    19

                          19

                                19

                                      19

                                            19

                                                  19

                                                        19

                                                              19

                                                                    19

                                                                          20

                                                                                20

                                                                                      20

                                                                                            20
                           Underwriting Result                 Trading Result
                  1st Annual CPD Conference 2008
                       Managing Claims Costs



                    Why do we have cycles ?

• Uncertainty surrounding the true cost of claims at the time
  business is written which leads to….

   1. Use of revenue year metrics as proxies for true
      underlying account performance.
   2. Potential problems with new entrants/rapid growers.

• Over focus on market share/premium income measure with
  a corresponding downgrading of economic return metrics.

• Over reaction to good news – Under reaction to bad news.

• Fear of being different.
                  1st Annual CPD Conference 2008
                       Managing Claims Costs




      1. Uncertainty surrounding the true cost of claims


              % of ultimate cliams paid by development year

       120%
       100%
       80%
       60%
       40%
       20%
        0%
              0    1   2   3    4    5   6    7    8   9   10   11
                                Development year




At the end of the year in which you wrote the business only
30% of claims are settled.
                   1st Annual CPD Conference 2008
                        Managing Claims Costs




           Uncertainty surrounding the true cost of claims

• When we come to reviewing the profitability of an accident year
  only 30% of our claims have been settled. 70% are exposed to
  future events such as

   • Claims inflation, Changing legalisation, Future medical
     advancements, Etc.

• When it comes to assessing the profitability of the business
  written last year the situation is much worse as 50% of the
  premium has yet to be exposed to risk. So it’s exposed to all of
  the above plus

   • Changing road safety standards (good and bad), Changing
     frequency levels, Economic climate, Weather ,Etc.
                                 1st Annual CPD Conference 2008
                                      Managing Claims Costs



                Uncertainty surrounding the true cost of claims

• Position is even worse when there is a major change in the
  external environment (and we’ve had lots of these recently).

• We need to be very careful when interpreting data.

   Number of claims per year         300

   Average Cost Old                        Average Cost New
   Duration 1            2,000             Duration 1    1,000
   Duration 2            2,000             Duration 2    2,000
   Duration 3            2,000             Duration 3    3,000


   Average Settled Cost
                     Year 1      Year 2     Year 3     Year 4

   Duration 1          200,000   100,000     100,000   100,000
   Duration 2          200,000   200,000     200,000   200,000

                                                                 Apparent reduction in
   Duration 3          200,000   200,000     200,000   300,000

   Average               2,000     1,667       1,667     2,000
                                                                 average settled cost is
                                                                 completely false
                    1st Annual CPD Conference 2008
                         Managing Claims Costs




           Uncertainty surrounding the true cost of claims

• Accounting for uncertainty is difficult !

• It leads to over and under estimates of performance.

• Accounting solution is to focus on revenue year accounting.

• Not a problem as long as you remember that the current
  revenue year performance can has ALMOST NOTHING to do with
  the performance of the business you wrote during the last 12
  months.

• Major problems arise when there is a confusion between
  performance on a revenue year basis and on an accident year
  basis.
                             1st Annual CPD Conference 2008
                                  Managing Claims Costs




Market performance – Let’s focus on the more recent revenue years



                               Motor Market Underwriting Cycle
     40%
     30%
     20%
     10%
      0%
    -10%
    -20%
    -30%
       92

             93

                   94

                         95

                               96

                                     97

                                           98

                                                 99

                                                       00

                                                             01

                                                                   02

                                                                           03

                                                                                 04

                                                                                        05

                                                                                              06

                                                                                                    07
      19

            19

                  19

                        19

                              19

                                    19

                                          19

                                                19

                                                      20

                                                            20

                                                                  20

                                                                         20

                                                                                20

                                                                                      20

                                                                                             20

                                                                                                   20
                              Underwriting Result                      Trading Result
                                                1st Annual CPD Conference 2008
                                                     Managing Claims Costs




                      What’s happened to premium over the period

                                                           CPI Motor Insurance 1989 - 2007

             200


             180


             160


             140


             120


             100


               80
                2

                         3

                                  4

                                           5

                                                    6

                                                             7

                                                                      8

                                                                               9

                                                                                        0

                                                                                                 1

                                                                                                          2

                                                                                                                   3

                                                                                                                            4

                                                                                                                                     5

                                                                                                                                              6

                                                                                                                                                       7

                                                                                                                                                                8
                 9

                          9

                                   9

                                            9

                                                     9

                                                              9

                                                                       9

                                                                                9

                                                                                         0

                                                                                                  0

                                                                                                           0

                                                                                                                    0

                                                                                                                             0

                                                                                                                                      0

                                                                                                                                               0

                                                                                                                                                        0

                                                                                                                                                                 0
              n-

                       n-

                                n-

                                         n-

                                                  n-

                                                           n-

                                                                    n-

                                                                             n-

                                                                                      n-

                                                                                               n-

                                                                                                        n-

                                                                                                                 n-

                                                                                                                          n-

                                                                                                                                   n-

                                                                                                                                            n-

                                                                                                                                                     n-

                                                                                                                                                              n-
            Ja

                     Ja

                              Ja

                                       Ja

                                                Ja

                                                         Ja

                                                                  Ja

                                                                           Ja

                                                                                    Ja

                                                                                             Ja

                                                                                                      Ja

                                                                                                               Ja

                                                                                                                        Ja

                                                                                                                                 Ja

                                                                                                                                          Ja

                                                                                                                                                   Ja

                                                                                                                                                            Ja
Strong profits coupled with low premiums – Have we reached Nirvana ?
                         1st Annual CPD Conference 2008
                              Managing Claims Costs



Is all this sustainable ? – Let’s take an accident year perspective


                   Motor Accident year and Revenue year results

 40%
 30%
 20%
 10%
  0%
-10%
-20%
-30%
-40%
       1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
                                                                                        (E)

                         Underwriting Result   Trading Result   Accident year



  The underwriting/trading result lags the accident year
  result – We’ve been loosing money for the last 2 years.
              1st Annual CPD Conference 2008
                   Managing Claims Costs




              Claims releases bridge the gap


        Net reserve oustanding per registered vehicle

3,000
2,500
2,000
1,500
1,000
 500
  -
      19 6
      19 7
      19 8
      19 9
      19 0
      19 1
      19 2
      19 3
      19 4
      19 5
      19 6
      19 7
      19 8
      20 9
      20 0
      20 1
      20 2
      20 3
      20 4
      20 5
      20 6
         07
         8
         8
         8
         8
         9
         9
         9
         9
         9
         9
         9
         9
         9
         9
         0
         0
         0
         0
         0
         0
         0
      19




        How much longer is this sustainable ?
                    1st Annual CPD Conference 2008
                         Managing Claims Costs



   Uncertainty surrounding the true cost of claims – Problems for
                  new entrants and rapid growers



• As the true manufacturing cost of a policy written today will not
  be known for several years it’s vitally important that appropriate
  metrics are used to measure business performance

• If it’s difficult for an established player in a steady state position
  to forecast claims costs imagine how hard it is for a new entrant
  or rapidly growing company to do so.

• New entrants often come in following several years of positive
  results but get in too late and write loss making business. It can
  take a while before they realise their mistake.
                 1st Annual CPD Conference 2008
                      Managing Claims Costs



                 2. Over focus on market share


• Targets are nearly always based on premium income.

• Growth targets are often unrealistically high.

• Generally only one plan prepared – what you do next year
  should vary depending on what happens to external factors.

• There needs to be much more focus on economic breakeven
  combined ratios and underlying earnings.

• There is generally no recognition of the existence of cycles when
  plans are prepared. If there was we would plan for a loss in
  market share as rates become unprofitable.
                   1st Annual CPD Conference 2008
                        Managing Claims Costs



                   3. Over reaction to good news



• All good news is factored in immediately. Bad news only gets
  included after it has happened.
   • Assuming 0% claims inflation because that’s what happened
       last year.
   • Assuming a continuation of a favourable trend rather than a
       flattening or a reversal.
   • Excluding “extraordinary” events from pricing on the
       assumption they will never happen again.
   • Pricing to breakeven on a good year (and consequently
       loosing money on the bad ones).
   • If a risk has had a good year it’ll have another one next year.
       If it’s had a bad year it will correct itself next year.
                   1st Annual CPD Conference 2008
                        Managing Claims Costs



               3. Eventual over reaction to bad news


• By the time bad news gets factored in we usually have had a
  couple of loss making years. This often leads to an pressure on
  reserve levels as these unprofitable years may be inadequately
  reserved.

• The combination of inadequately priced business coupled with
  reserve pressure leads to an over-correction in rates as
  companies attempt to correct current year profitability and shore
  up reserves.

• The reserving problem can be particularly severe if the bad news
  affects all outstanding claims and not just the last couple of
  underwriting years (such as a step change in claims inflation as
  happened in the mid 90’s).
                             1st Annual CPD Conference 2008
                                  Managing Claims Costs



                       3. Eventual over reaction to bad news


                                    Market Reaction - Bad News

40%                                                                                           180

30%                                                                                           170

20%                                                                                           160

10%                                                                                           150
 0%                                                                                           140

-10%                                                                                          130
-20%                                                                                          120

-30%                                                                                          110
-40%                                                                                          100
       1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
                                                                                        (E)
                                                  Year

                         Underwriting result   Accident year resut   Premium Index
                   1st Annual CPD Conference 2008
                        Managing Claims Costs



                      4. Fear of being different


• Your view of the future cost of claims is a combination of
   • your own data
   • The manufacturing cost implied by competitor rates.

• When your view is out of line with the market there is a natural
  tendency to question your own assumptions and place more
  weight on the market view.

• This problem is exacerbated by rapidly changing external factors
  and a lack of reliable external data.

• Sometimes its hard to believe how irrational everybody else
  seems to be. They are all clever people so isn’t it more likely
  that your wrong ?
                   1st Annual CPD Conference 2008
                        Managing Claims Costs



                     4. Fear of being different



• The cycle lasts several years so you need to remain strong for a
  long time before your proven right.

• Active cycle management requires you to shrink as the cycle
  moves down – not many companies allow plans with falling
  volumes.

• A better strategy comes from
   • Rapid expansion during the over priced phase (geometric
      growth)
   • Slow decline in volume as prices drop.
                   1st Annual CPD Conference 2008
                        Managing Claims Costs



                  Underwriting Cycle – So what ?



• Markets love stable earnings. Cycles destroy value as they
  reduce the perceived value of your income stream.

• Diversification by line can help but lines are often more highly
  correlated than people think.

• Active cycle management can help an entity maximise its value.

• Focus on economic indicators rather than reliance on
  “accounting” measures will help inform managements decision
  making process.

• Sometimes you just can’t grow profitably !!!

								
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