THE PROPERTY – CASUALTY insurance industry is ignoring the fundamental implications of its cost structure at its peril. While p-c insurers turn a blind eye toward the impact of chasing premium while discounting good underwriting, the industry sinks further into the soft market cycle and declining profits.

Yet solutions are easy to find among strong Insurers that manage for the long term.

The mess we’re in today is obvious and a repeat of the past. The p-c industry generated underwriting profit in only four of the past 39 years from 1967-to-2005. That means it achieved an underwriting profit only once a decade, on average -a dismal performance.
Prices keep sliding and insurers keep trying to make it up with increased volume, a short-term solution that ignores the fundamental nature of insurance and repeats the sins of the past.

So, what is the solution? A long-term management strategy that includes creating unique and customized insurance products that compete beyond price, emphasizes profitable underwriting and outstanding claims services, and takes advantage of global opportunities.

The only way to thrive long-term is to manage with a long-term perspective. We’ve seen competitors dive into the market with low prices and big marketing splashes. In a few years they find out it’s harder than they thought and they are gone, either by choice or through bankruptcy.

Increased capacity in the insurance market and Wall Street’s demand for short-term results encourages many to venture into the insurance market. The most recent trends in p-c insurance certainly demon­strate the trend toward increased capacity, according to the Insurance Information Institute. From $289.6 billion in 2001, sur­plus in the market steadily increased to an estimated $496.6 billion in the first quarter this year.
Too may insurers believe that nigh-capacity utilization, in the form of continu­ous pursuit of market share, is the way to profit-ignoring the reasons it won’t work and never has.

COST STRUCTURE

Unlike other industries, insurers have a very high percentage of variable costs-primarily losses, commissions and premium taxes. The largest of all these costs-issues is unknown and unknowable. In contrast, commodity-producing industries, such as the airlines, have high fixed costs.

Too often insurers act like commodity producers. When the market softens, they try to compete by cutting prices and seek to make up for the price decrease with increased vol­ume. That puts pres­sure on underwriters to fill quotas, rather than select good risks. This, in turn, produces high volume but shrinking profit margins.

In industries with high fixed costs, com­petition can be devastating. When insurers treat their services like commodities, com­petition is devastating for them as well.
But competition isn’t devastating for insurers that refuse to play the game and do not produce commodities. Instead, they sell highly differentiated products that can withstand price pressures.

Chasing market share is not the answer. Insurers need to refocus on the bottom line.
Too often insurers brag about premium and not profit. Sure, $20 million in pre­mium is impressive. But if that $20 million only produces $3 million in profit isn’t it better to have $10 million in premium that produces the same $3 million in profit? There is nothing wrong with having a smaller book of profitable business.

Economies of scale are virtually nonex­istent in the insurance industry. Technol­ogy has become available at lower prices, and we’ve learned to use it to service more efficiently. This has eliminated whatever economies of scale might have existed previously. There is no longer an inherent advantage in being large.

Growing smaller, not larger, can be the answer. But for this to happen we need to value outstanding underwriting above all else. For too long insurers have down­played the value underwriting profits because they believe an underwriting loss is inevitable.
The concept of cash-flow underwriting, in which underwriting losses are offset with investment income, is a bad idea, and one that has been around too long. Underwriting losses are not inevitable. In fact, companies with strong balance sheets achieve underwriting profits routinely.

We need to stop pressuring underwrit­ers to put premium on the books when it comes at the expense of profitability. Many of the catastrophic insurance company failures of the past were caused by under­writing departments that caved in under the pressure from marketing departments seeking growth at any cost.

Good underwriters can make a company shine or throw it into the tank. We need to train them well, encourage their curiosity, and back up their decisions. Bonus plans and other forms of compensation should be aimed at rewarding underwriters for pricing and risk selection, even if it means slower market-share growth.

Nearly every insurer can improve its profitability by writing less-not more­ business and seeking increased market share only when the expected profitability is high and in excess of required rates of return.

COMPETING ON PRICE

While commodity producers are forced to compete on price, insurers do it at their peril. History shows that many insurers that compete on price disappear when their reckless price-cutting comes home to roost.

In contrast, insurers that differentiate their products can hold fast to profitable price. They know their customers appre­ciate value-added service over price
Insures realize that price isn’t the only consideration when they need help and need it fast, especially when making a claim. Customers increasingly care about service and stability and are willing to pay for value.

An insurer can hold the line on price if it delivers a differentiated product that in­cludes outstanding customer service. Sure, a few customers will leave, but most will stay and the company can ignore the busi­ness cycles.

Custom solutions, underwriting and outstanding claims services differentiate insurance products.

Outstanding claims-handling means providing policyholders with the best legal representation we can buy. That’s a big value-added service.

Insurers need to develop a diversified ar­ray of specialized products that fit custom­ers’ individual needs. No more template underwriting.

If we provide differentiated products, we can hold our prices when everyone else goes off the pricing cliff. We can operate as if insurance cycles don’t exist.