The recent pronouncements by both brokers and insurers that they must show pricing and coverage discipline to avoid the next soft market reminds me of the ancient parable about the scorpion and frog. We all remember that the scorpion convinces the frog to carry him across the river and that half way across, the scorpion stings the frog. When asked why he caused their certain death, the scorpion replies simply, "Because it is my nature."
While there are a number of reasons for the seemingly inevitable downhill slide to soft markets in commercial lines, the role of the broker cannot be overlooked or minimized. The coinciding rise of the broker as the dominant large commercial account insurance intermediary and the extended soft market cycles can be traced in part to the inherent nature of the broker's role and effectiveness in representing clients' interests.
The reason for this downward force on the cycle is better understood when viewed from the perspective of vendor sourcing of purchased expenses.
Almost all major corporations have instituted rigorous processes for sourcing and negotiating favorable terms for purchased expenses. In those efforts, commercial insurance is the one area untouched by outside sourcing consultants. In retrospect, the broker has been one of the most effective sourcing agents over the years, even before the methodology was fully developed in other industries.
The broker has regularly pursued the lowest risk transfer cost for clients in the annual renewal cycle. So, when the industry moves to drive prices to adequate levels, the resulting hard market is short-lived because of the natural force of the broker driving down prices and improving terms for clients, even at the expense of reduced revenue in a soft market.
As such, how might the next cycle be less severe than those of the past 25 years? Can underwriters, brokers and their clients work together to mitigate risk while generating an adequate return to the insurer? Not likely, except for the few underwriters disciplined enough to let unprofitable business flow to the lowest bidder. But a number of actions can counter the broker's natural negotiating leverage.
To stem the next cycle, insurers must exercise extreme underwriting discipline to ensure they are managing their economic risk while meeting the needs of the brokers and their clients.
First, insurers must install rigorous controls with detailed information at the point of underwriting. The underlying economic cost of coverage must be clearly understood. Tools such as probabilistic models can help the underwriter avoid tempting but high-risk bids.
Second, greater pricing transparency must be achieved. Unlike personal insurance, where competitors' rates are fairly accessible, commercial underwriters seldom know precisely what their competitors are bidding and how they might be charging for extended terms and conditions, putting the broker at a distinct advantage.
Improving ongoing competitor surveillance is essential to overcoming this disadvantage. Capturing, documenting and sharing this information on each renewal and competitive bid can significantly increase desk underwriters' insight during negotiations.
The other important key to reducing the impact of the next soft market is for underwriters to change the risk mitigation solution options. While the client, assisted by the broker, is rightly seeking the lowest economic cost to mitigate risk, the solution may very well not be that proposed by the broker.
Walking away from an unprofitable risk must be accompanied by offering alternative risk transfer methods that satisfy both the client's needs and the insurer's profit objectives. Ultimately, greater underwriting discipline and the gradual adoption of alternative risk transfer methods will contribute to more-rational pricing and less-severe cycles.
Will the next soft market cycle be less severe? History and the current market pulse suggest not. However, if everyone practices greater discipline, there may be an opportunity to change our natures and safely cross the river together.
