Coping with the insurance cycle

Not many years ago, former UK Chancellor of the Exchequer (and later PM) Gordon Brown famously called the end of economic boom and bust. He should have known better. It wasn’t long before he had to retreat, when the global financial crisis of 2007 pushed the UK back into bust mode.

Almost every economic system is subject to cyclicality over time, especially including the global insurance system. Just as UK economic cycles did not end at the behest of a UK politician’s wishful thinking, the insurance pricing cycle persists despite ‘technical pricing’ and other innovations once hoped to herald its end.

Cycles are a product of human nature. Far from the uber-rational perfect markets driven by some mythical Smithian invisible hand, two simple factors drive the cycle of insurance economics, just like any other: fear and greed. And since the fear is not FoMO but FoLM (Fear of Losing Money), it counts as greed too. Since human nature at that level isn’t changing very quickly, cycles will not end any time soon. The only thing which is likely to change is their length, and possibly their severity. That means, from a practical perspective, that insurance risk carriers must possess and use the tools and resources necessary to manage them.

Hang on for the roller-coaster ride

Today all of us in London and around the world are observing the slow ascent of insurance pricing from the fathoms of a very deep soft market. We are heading towards the cyclical peak which lies inevitably ahead at some point in the rapidly approaching distance, but which, understandably, no one is yet inclined to call.

Diverse factors are propelling the current cyclical shift, from litigation funding to changing weather patterns, followed by Covid and its treacle-like effect on everything. Now new factors include punishing sterling exchange rates, a return to inflation alongside rising interest rates, and – to cap it all – Hurricane Ian, which some are calling the largest insured loss in history.

In combination, those last two factors may drive the market finally towards the type of hardness that only old-timers like me remember, when the price of everything is up enormously, and some risks are uninsurable in any practical sense. That’s because surplus capacity driven by very low interest rates had acted as a brake on price rises. Money was so cheap that it delivered adequate returns to investors even in the softening market. The surplus has been eroded, and it’s not flooding back. And as surely as the market will harden further, it will soon after begin to soften. This time won’t be different.

How to cope

For risk carriers, the big challenge presented by this fundamental reality of our market is deploying people – underwriters – who are able to manage the cycle. But even the best of them cannot do the job on instinct alone. As most people now believe, underwriting is an art and a science at once. To get the science right and manage their portfolios across the cycle, underwriters must have exactly the right data at their fingertips.

To ensure risk carriers are able to profit from the cycle while satisfying human nature, underwriters must have the information that assuages greed and tells them it’s time to walk away. Equally, it must confirm their instinct to leap in when the time is right. They must see the wisdom and financial benefit of staying on the platform when the soft-cycle train leaves the station. Similarly, they must understand the benefits of giving some ground when times are tough for buyers, because they understand that their technical rates are sufficiently lower than the market price to give their beleaguered brokers some good news for clients.

To overcome the cycle by getting the right data into the hands of underwriters at just the time they need it is a relatively simple process. It requires only that insurers have the right technology, a platform that puts exactly the information each underwriter needs onto their screen precisely when they need it, while hiding the complexity of the ungainly mass of “big data” which inevitably lurks behind. At Quotech, it’s all in a day’s work.