His frustration mounted as the broker sitting across from me shared his vision for his organization.
“One of our biggest challenges is keeping track of hundreds of carriers,” he said emphatically. “We would love to consolidate but we can’t because carrier appetites are so narrow. Why do carriers decline so much business? Isn’t there a price for every risk?”
This is a question we hear a lot and, an important one to wrestle with. Is there a price for every risk?
Theoretically, the answer is yes. Every risk has a unique set of risk attributes that interact to create an expected loss cost which, loaded for company expenses and profit, results in a price. A company that charges an accurate price should, over the long term, achieve its target profit margin. Conceptually then, there is no rational reason why a company would choose to decline business when it could instead grow the top line and achieve its target return. In that sense, the broker is correct: it makes no sense for carriers to decline so much business.
But as is often the case in the insurance business, theory and reality don’t necessarily align as other factors in play interfere with this seemingly straightforward expectation.
We often don’t know what the “right price” is.
Actuarial pricing models sift through vast amounts of data to identify the pricing adjustments indicated for various risk characteristics.
The less homogenous the business, the more data is needed. Personal lines and smaller, more commoditized commercial lines business are made up of largely homogeneous risks for which data is readily available, so reasonably accurate prices can be calculated for almost all risks. But as commercial lines business gets progressively larger, more complex, and more heterogeneous, the data associated with individual risk factors gets thinner and the pricing gets more difficult.
In the excess and surplus lines space, many risks present higher hazard risk characteristics for which most companies don’t have sufficient data to be confident of pricing. For some exceptionally unique risks, there may not even be enough data available in the industry to develop accurate pricing differentials across widely disparate risk characteristics.
The “right price” does not just depend on the insured; it varies by company.
Every company brings its own expertise to the business it writes. Differences in underwriting, policy wording, loss control, and claims handling directly impact the required price. Optimizing these functions for the full spectrum of less common, often higher hazard risk factors does not make financial sense for most companies. This opens the door for the array of specialist MGAs and carriers who focus on and perfect their offerings for more bespoke business, often enabling them to charge lower prices than others for the same business and yet be more profitable.
Carriers and other capacity providers often overreact to severity relative to price.
Consider a risk with a $5M limit that is perfectly, actuarially priced at $25,000. If that risk experiences a full limit loss, there is almost never any discussion within a company about whether pricing was correct. Whether the premium charged was $10,000, $25,000 or $50,000 makes no difference relative to the loss. All eyes are on the immediate damage done to results. This bias flows directly to underwriting decisions on the front lines.
Regulation constrains what carriers can charge.
For admitted lines of business, the requirement that rates be filed limits carriers’ ability to adjust pricing for individual risks. While there are some mechanisms within filed plans to enable flexibility in pricing, such as schedule rating and large risk rating exceptions, it is not always possible to reach an adequate price for every individual risk. In those cases, an underwriter’s only option is to decline.
So we return to our original question: is there a price for every risk? The short answer is yes, there is. But price is not the only consideration; other structural dynamics throughout the insurance system play a role. The ecosystem of MGAs, specialists, admitted and surplus lines carriers, and reinsurers is continually flexing around these dynamics to supply capacity at varying prices to the market.
Agents and brokers will continue to play a critical role in navigating that capacity to secure the best pricing and terms for their clients. It is not realistic to expect declinations to be eliminated. But companies that come in alongside producers, thoughtfully and responsibly making the most of sound actuarial, underwriting, and claims practices to say “yes” to more business, play an important role in helping producers to be as efficient as possible, optimize their markets, and best serve their clients.