This a shortened version of Making Risk Flow podcast, episode: “The Softening Market: Challenges and Opportunities for Insurers | James Anderson, EY." In this episode of the Making Risk Flow podcast, Cytora’s Juan de Castro is joined by James Anderson, Partner at EY, to delve into historical and current challenges around the soft and hard market cycle. James, an experienced actuary turned consultant, shares valuable insights on the use of analytics and technology to drive business improvement.Together, Juan and James discuss the challenges and changes facing the insurance market and the importance of preparing businesses by developing adaptive strategies. They also cover the management of the potential for a new softening in the market, why insurers need to focus on rate adequacy, establishing a clear strategy, and improving technical pricing capabilities, and the significance of culture and compensation in aligning underwriters' behaviour with company goals.
Listen to the full episode here
Juan de Castro: Hello, my name is Juan de Castro and you're listening to Making Risk Flow. Every episode, I sit down with my industry-leading guests to demystify digital risk flows, share practical knowledge, and help you use them to unlock scalability in commercial insurance. James, thank you so much for joining me today. And you've got a very unique background and experience, you're one of those professionals who spend a lot of time as an actuary in different insurers and now you've shifted or moved to consulting, advising insurers. So let's start. Give us an overview of your background. Where do you focus on?
James Anderson: Yeah, sure. Happy to. So yeah, as you said, right now, I'm a consultant, I work at Ernst & Young and I lead their pricing practice, so really helping our clients develop and transform their pricing capabilities, a key part of the underwriting process and that you've got that strong pricing framework to allow the management of the portfolio. I've been doing that for about a year and a half. Prior to that, I worked for a long time in the industry. I worked at Swiss Re, at Brit Syndicates, and for 12 years at Allianz. And in that time, I did all sorts of traditional actuarial roles, reserving, capital, a lot of pricing, but I've also kind of done roles maybe a little bit outside of traditional actuarial, so a lot of data analytics, quite a bit of portfolio management, and also some underwriting strategy roles. But I guess if I was going to pull them all together, it's always this sort of combination of using analytics and technology and data to help improve the business and drive business improvement, whether that's incremental improvement over time or kind of transformational leaps.
Juan de Castro: And your type of background, I always find it fascinating, because you've done it. But you were probably not happy enough with how things work or how some of the pricing works in different insurers. And now you're on the other side, kind of advising and helping the industry move as a whole, but while keeping your knowledge of why things are the way they are and why some things are difficult to change, right? So that realistic view, I think it's also very important. I think that's why I'm very excited about this chat.
James Anderson: Completely agree. It's a real privilege getting to do the job I'm doing now. And I just get to see how all the different companies tackle what are very similar problems in quite different ways. And yeah, as you say, the real aim is to transform the market and really make technical pricing in the London market, not a sort of back office function, but an integral part of the business.
Juan de Castro: Definitely. So one of the areas I know you focus quite a lot on is helping insurers, what we call, managing the cycle. So this transition from soft to hard cycle and the other way around. Perhaps let's start there with some context. So some people might be too young to know what happened in the last soft cycle and what can we learn from it? So let's start perhaps there. What happened in the last soft cycle?
James Anderson: Absolutely, sure. I mean, I was in the trenches for this, so yeah, happy to share. So obviously the insurance market is very cyclical. Capacity comes in and out, rates go up and down, and it is in a large cycle. If we're looking back sort of prior to 2020, there were some very soft years and the decision-making wasn't great. If you look at Lloyd's data, you had sort of five years in a row where the combined ratio was at or above 100, and that's just not a good place to be. And a lot of the companies, I think we went beyond the point of the early years of the softening market. It's hard to spot and it's hard to know when to turn, but it sort of went beyond that until everyone knew we weren't in a place where we were long-term profitability sustainable, but there was a real struggle to react and show the courage to draw the line. Unfortunately, in the end, it was the regulator, Lloyd's, that particularly for the Lloyd's market drove it. They brought in the Decile 10 quite a blunt instrument, but it was what really drove the change in the market. And that isn't the greatest advertisement for us as a profession that we let it get that far. So as you say, we have spent a lot of time thinking about both what happened last time in terms of the performance, but also how can we do better in the future? And that's definitely one of the areas we're focusing on. And I think the area we kind of thought was particularly interesting to talk about today.
Juan de Castro7: Definitely. And one of the things you mentioned, show courage to draw the line in that period. So when something like that happens, five years in a row of losses in the London market space, is it driven by rates going down, and that's obviously a big part of that, is that the major reason why the market as a whole loses money? Or is it that there's not enough rigour on risk selection and being more granular on how you price different types of risks?
James Anderson: It's definitely both in that I think, and maybe we'll come on to it later, but we've done a lot of analysis, particularly on the Lloyds market, where there's a lot of available data. We've got 10 plus years of data, and we can categorise Lloyd's syndicates by loss performance and who's done well and who's not done well. I think what's definitely clear is if you look at the top quartile, actually they made money in almost all of the last 10 years. So you can do better than the average. You can outperform and you can make money through the cycle. But it does get increasingly challenging as the rates go down. Part of it is that the rates are going down, but also the terms and conditions are widening. It's a lot harder to make those good selections and in a very defensive mode. And that probably comes on to one of the big insights we've got, which isn't, I doubt, a surprise to anyone, which is when we look at that sort of the top performers versus the kind of worst performers over the last 10 years, one of the real differentials when you look at them in terms of their growth trajectory is that the top performers during those soft market years, they were growing a little to stable, definitely shrinking their market share. And then when the market turned and it was hard, they very aggressively grew and regained all of that market share in the years where they were making money. You contrast that to the insurers who were in the bottom quartile and they were growing hard into the soft market, and then once the market turned, they were actually often remediating and shrinking when the most logical thing would be to grow, and then only caught up with the growth later. And across all the analysis we've done in terms of looking at what's the drivers of under and over-performance, I think probably that is the starkest one of what really is driving the differential in the market.
Juan de Castro: That's very interesting. You mentioned two things there. One is that the distinction between the top performance and the worst performance is the worst performers were slower to identify the changes in the market and decided not to keep on growing. Well, it's probably the same point that identifying the market has changed the hard cycle again, and then aggressively and being decisive enough. So let's touch on both those two things. Why were they not ready? I mean, these are some syndicates that have been running for many, many years, you would expect them to have this capability. So what happened? Why do you think some of those syndicates were not ready to identify that shift in the market?
James Anderson: Yeah, so I think if we're talking first maybe about the shift down, I think there's two parts of this. There are some foundational things that I think as a market we were weak on and the best performers were better. I think a common feature of the best performers is they were much more data-driven and they had much stronger controls around pricing. And I think it's fair to say a lot of companies, their pricing was done in Excel spreadsheets, probably done after they'd written the risks and the data quality was very poor so that you really didn't get the value you should have. And then also a lot of companies were struggling to have a very clear view of where they were in terms of rate adequacy, either from their pricing tools or from their wider analysis, just because it was underinvested, just because they didn't have the data or the steering framework to manage it. But yeah, I think that's one part of it. But, as you went into the fourth, the fifth year of the soft market, I don't think you needed to have a particularly strong foundation to know that we were in trouble as a market. Therefore, that was also about the strategy, and I think a lot of the challenge is that all these companies have shareholders who are expecting growth, and improved dividends each year. And it's very hard to manage those stakeholders. And it's particularly hard to manage them when you're at the bottom of the cycle, and you're trying to give them bad news and that the bad news is going to continue. So there is something about having a clear messaging and a clear plan around the cycle to try and mitigate that. So there's that bit about a lack of ability to manage their stakeholders, probably a lack of a clear strategy of how they were going to adjust their approach through the cycle. And then also something around the culture in that you are asking big things from your underwriters to be disciplined at a time when everyone else isn't. So that does require the right culture. It does require the right compensation as well as structuring. So there's a lot of stuff, some of it foundational, some of it kind of more strategic topics. And I think the main point is none of that can be fixed overnight. So it's really critical to be delivering that and building those capabilities while you can, while the going is good. I guess I've answered your first question. It's very similar to the second in terms of the nuance on why weren't people reacting to the hard market, you know, I think everyone knew, you didn't need any clever monitoring to know that we were going into a hard market, the rates were improving. I think the problem is if you'd been really growing heavily into the soft market and your previous years were doing really badly, a lot of companies either had Lloyd’s coming and intervening and telling them they needed to clean up their books and not letting them grow, or they had parent companies or investors doing the same. So it wasn't so much about the capabilities around monitoring, it's more that the mess they got themselves into, all their time and effort was consumed in fixing the problems and the burning fires, not in terms of the opportunity to grow.
Juan de Castro: Yeah, this is a brilliant summary of things to avoid in the hard-to-soft market than in the soft-to-hard market.
James Anderson: Which I appreciate is easier to say than to do.
Juan de Castro: Yeah, but at least it's important to have a framework of what didn't go well last time and what do we need to get it right. Because there are many people talking about how far away is the next soft cycle. Are we getting into a new soft cycle? What are your views on that?
James Anderson: I think we're not there yet. We've had six years, I think, now of hard rates, which is incredible and good news all around, I think there's a reason for that in terms of a lot of things happening. A lot of it's driven by inflation and you have to question how much rate you've really achieved after you've brought in all the additional kind of social inflation and other types that have been driving some of our adverse back-end deteriorations in particular. I guess where we are now is that it's gone from being a kind of purely hard market to now being in that place where, by line of business, by region, it's differentiated. So I appreciate that I'll say this now, and then if you listen to this podcast in six months, I'll be completely out of date. But yeah, at the moment, I think what we're seeing from all the work we do at EY, particularly all the sort of reserving work we do, which gives us a great view of the market is, but you know, I think you could get a lot from reading the industry press as well, there's some lines of business which have definitely already turned and are softening. I think particularly some parts of financial lines have seen some very big rate increases, and are now seeing some quite big rate decreases starting to come down. You've got some other lines that are definitely still seeing big rate increases, you know, property being the big example. And then you've got a lot of other lines that are somewhere in the middle, some of which potentially starting to be in a place where once you allow for all the inflationary aspects, maybe you are already seeing rate decreases, some that are still getting some smaller rate increases. But definitely in total, the pace is slowing down, apart from property. And there are some lines that are starting to move into negative. I mean, I think the point I always want to make here is that the year where you've had a -2% increase, you're still probably your second best year ever in terms of profitability. Just because the rate's gone negative doesn't mean that immediately a bad class and you need to exit. But it starts to be about really understanding where you are, and I think rate change is an important metric and gets a lot of focus. It can get too much focus. And I think really one of the things that we're talking about a lot is switching the focus from not just rate change, but also to having a really clear view of rate adequacy, because that's the matter. That's the metric that's saying, have you crossed the point where you're no longer making money?
Juan de Castro: Exactly. If I hear correctly, there are some early signs of the market as a whole softening, potentially, but it's definitely happening in some lines of business. So you would expect some insurers already starting to take action on at least those that are softening, right?
James Anderson: Yeah. And I guess maybe I just, the only thing I'd add to that is there is a huge amount of uncertainty here, right? I mean, there's always uncertainty, but there's a lot of stuff happening at the moment in terms of social inflation, you've got the economic conditions in general, you've had the fact that a lot of companies have really heavily remediated their books so that their past performance isn't necessarily so indicative of the future because they've got a very different profile underneath them. You've got the classic kind of longer-term things, things like climate change. I think COVID had an impact where you've seen some really good years the last few years, but some of those were the COVID years, and is that real or is it just delays? There's so much uncertainty in where we are at the moment that I think some of that is prolonging the hard market, but it's also making it really hard to have a very clear view of where exactly you are on that kind of rate adequacy level.
Juan de Castro Yeah. But this is almost the perfect environment to then start going back to your analysis of what didn't work well in the hard to soft and soft to hard market. I would love to hear your thoughts on two things. One is, how are you advising some of your clients on how to be best prepared for a potential softening or a more acute softening of the market? And the second one is, some of the components you were describing earlier that were the problem in the last shift from hard to soft, are those still the case now, like pricing spreadsheets, etc? So let's start with the first, how do you advise clients?
James Anderson: I'll go with a spoiler that, yes, a lot of the problems are still there, but we'll come on to that. Yeah, so I mean on a high level, we have a sort of framework that we would use to advise and also a health check of where you are. And a lot of the things I talked about earlier in terms of the first bit would really be around the strategy in terms of, is there a clear cycle management strategy? Is that clearly communicated? Do you have playbooks in place to address that? Work at identifying all the levers that you can pull to manage your way through the cycle. And I think importantly, some of that is internal. Some of that is making sure you're ready and you're prepared. But some of that is also messaging to the market and the stakeholders to make sure that they're not surprised in a couple of years when you start pulling back, that that's what they expect from you, so that you're not in that position where you know that the right thing to do is to be disciplined, but actually your shareholders are demanding that you grow because that's a very difficult place to be. So there's that strategic element. I guess the second element we've touched on a lot already, is having a really strong, robust way of being clear on where you are in terms of rate adequacy. And you know, some of that is very basic things that a lot of companies, their rate adequacy assessment is intermingled with the planning and with financials and with levels of prudence that they're holding, and they struggle to be very clear on ‘this is our clear best estimate view of where we're at’, even at quite a high level. And then I think pricing tools and robust pricing lets you then drill down and see that on a much more regular basis. Beyond that, we're doing quite a lot of work with some of our clients on things like early warning indicators, but you know, I think there's a foundation to get your rate adequacy right and then you can be clever and think about are there specific metrics we can be monitoring to for particular lines of business that will flag things earlier and that's very valuable as well. So I think those are the two first bits. And it comes to your point about, are we ready? Is there's a bit that's easy to say, but it's about that framework of having a clear process to monitor and that's the data and the people and the process and the common understanding of your metrics to be able to have a regular process to understand where you are, be referring to what your plans were at different points in the cycle, and to be able to then, at a portfolio level, execute that. That's the first robust piece you need. The second bit is then, okay, at a portfolio level, you've got strategies and you've got targets and you're trying to, it’s then how do you execute that into the front line, into the underwriters in a way that still gives them what is right, that they're experts, giving them the autonomy to make the underwriting decisions, but giving them guidance on what's expected and what they should be focusing on at different parts of the market. And that's where you can do that old school, particularly if you're in a small company, and just lock all the underwriters in a room for 15 minutes every morning. But I think the more you have larger companies, the more you have a digital environment. Having that way that there's technology and analytics enabled to take a plus 5% rate on this line and cascading that down in a targeted way to the individual portfolios is an increasingly critical part of that. And then I guess my last point, which I kind of said at the beginning as well, is also I think culture is a big part of this and really needs to be thought through. Culture and compensation and what you're asking for, your underwriters really need to buy into the idea if you're asking them to, at a time when all their friends in the market are writing big lines, making names for themselves, getting taken out for dinner by the brokers, you're asking them instead to be disciplined, cut their lines. It's not necessarily going to make them feel great at that moment, and you need them to buy into the culture of the company, to believe that the company is going to back them, and their compensation is if they write less top line, that they're not going to lose all their bonuses and be punished for it. So there's a real key part of building that belief in what you're doing as a company. And there's lots of different ways to do that, but it's not like EY has a magic source for that.
Juan de Castro: And that links really well with your first point, which is having a clear strategy. And then the other strategy then cascades into the culture. So you mentioned four dimensions, and at least four broad buckets of advice, around strategy, rate adequacy, the framework to monitor and enable the underwriters to execute on the front line, and then the culture aspect. Let me just touch perhaps briefly on each one of those. You've been giving a really good overview, but on strategy, what does that look like? Is this like a big piece of work? Is this more just a clear set of guiding principles? What should it look like?
James Anderson: Yeah. And I don't think there's a right answer. I think that different companies will do that in different ways, probably linked to the last point again of what's their culture, how do they like to operate? But yeah, I think in some ways having some guiding principles of what your approach is going to be. And then some of this starts to be personal opinion, I've always got an opinion that if you can't define what good is, and if you can't define the trigger you're going to act on, then you haven't really got a plan. So having some clarity on these are the things that we need to see, if we see these things, then we're going to do something. Even if you maybe don't want to tell the whole market that, but at least internally having some clarity on what metrics matter to you and what they would have to do for you to react, I think it's really important because it draws the lines in the sand. And then there's the much more, “and what do we do”, which is going to be very dependent on the company. You know, there are some obvious buckets about underwriting discipline, expense management, capacity management, reinsurance, purchasing all the standard things you'd expect. And it's just sort of thinking these through and defining the way that your company will deliver those.
Juan de Castro: Yeah, and that links with the last I mentioned on culture. You define the strategy, and I think your point about incentives and compensation is a brilliant one. Which is, as an underwriter, you can imagine what excites underwriters is writing more business and growing the book and being more relevant and gaining market share. You have to deliver a really strong message on, well, in this next phase, actually what we value is something different, to your point, and perhaps the compensation should be much more linked to great advocacy or the actual profitability of the book?
James Anderson No, exactly. It's such a difficult and really complex element, that sort of compensation design, because you can tell your underwriters we care about discipline and you need to be really focused on the bottom line, but if all the compensation you give them is top-line driven, you're sending the real message of what matters to them. So it's not my area of expertise, but I’m in awe of the people who do design this, because there are so many unintended consequences that you need to think through and be really clear about what you want to get out of this compensation and then design it around that. So yeah, I think it's critical and it's a very challenging area. The usual challenges of insurance, right? You can't tie it to performance without asking the underwriters to postpone their bonuses for five years or something. And there is some element of how you recognize good performance in a way that's not gameable, but it's timely.
Juan de Castro: Yeah. Yeah, we're shifting gears to the third dimension you mentioned, which was that framework to monitor what's going on and then enable the execution. And that is something actually which I also talk a lot with my clients, which is, what is the process by which you capture data to understand what's going on and have real tools to be able to influence the front line other than sending an email to your underwriters or getting them together in a room? So when you've seen this done well, what does it look like?
James Anderson This is definitely an area where the market is focusing a lot, spending a lot of time at the moment, but I think it's still partway through the journey. I think we sort of talked at the beginning about how a lot of companies, all their pricing sits on Excel, decoupled from the underwriting process. And that's definitely been recognized. And I think a lot of these are building out improved pricing. And also, sort of to your point, I think the best people are thinking about it, not just as here's a pricing project that needs to be, we're going to move off Excel onto a new platform. They're thinking about two things. They're thinking about it holistically as part of the underwriting process and journey, and they're also being really clear on what's the value we're getting out of this, and let's build towards that value. And for me, a huge part of the value is what we're talking about here of, as you're saying, that you have really systematic ways that the data is captured. And the data, as policies come in, are triaged, and that sort of top-down guidance is brought in as part of the process so that the underwriter is given a lot of insight at the point of underwriting. I think if I were going to break this down into three categories, there is this one category: improve your technical pricing, move it onto a systematic platform, have much stronger data and analytics behind it, make the pricing a lot more transparent, so that the underwriter really understands, can influence the technical price in the right way, and buys into it as a robust benchmark. The second part is then integrating it into the wider underwriting process so that it's not five times rekeying separate kinds of backend processes. It's a key component of the underwriting. And the idea is that the underwriter is not spending their time doing manual data entry. The idea is that the data comes all through to them naturally and they spend their time making good underwriting decisions, enabled by robust technical pricing, robust insight around the risk they're writing. And then I guess the third part of that linked to what we've been talking about before is one, you've got these technologies that are enabling the underwriter to get more insight into the underwriter to be a more automated, less manual process. In that data capture, you can then flow back through all the insights you're seeing and you get to be able to see the change in the rate adequacy a lot quicker. And then to have the framework within the company, which is more around process, and when I built these before, actually, a lot of it's about getting everyone to agree on the same data definitions. You can have five hours where everyone's got their own version of the loss ratio and they're arguing why theirs is right. So building those processes, building those common languages and understanding so that there's a really strong process to monitor what you're seeing and quickly react and flow it back down.
Juan de Castro: I just love this concept of getting rid of the spreadsheets. And I know this is also something quite close to Jamie, who's now at Hyperexponential, who worked with you back at the Allianz. So it's just painful to use spreadsheets. But I think that is almost the minor evil in the whole thing, right? I think the two big things that it prevents is, one is it doesn't give you the capabilities to analyse what's going on. So just to capture the data. The second thing, it doesn't also give you the ability to influence decision making. I think that is when you talk about big capturing and analysing the data so that then you can influence the triage and provide insights into the underwriters. It's really closing the data flywheel.
James Anderson: And it's enabling a different type of underwriting, which is, I think, newer to the London market than it would be to the kind of personal lines of that much more portfolio underwriting view of I'm not looking at every risk, I'm looking at the portfolio that my underwriters are writing. I'm identifying trends and I'm setting, tweaking our approach and feeding that back into the underwriting. That's a really important skill that I think we're going to see develop more and more in the London market. And I know some underwriters who are brilliant at it. And I know some who are much more comfortable doing the pricing, each individual risk, and it's that development over time is going to be really interesting to see how it plays out.
Juan de Castro: Definitely. And now that you're advising or working with many of these London market players, how fast is this evolution of driving this sophistication in pricing happening?
James Anderson: I mean, never fast enough, but there has been a real shift over the last three, four years. There's been a lot more, I think, recognition that pricing was underinvested. The framework around pricing hadn't been invested in enough. And a lot of companies are putting time and effort into building that up. And kind of going back to the topic of the kind of market cycle, I think, recognizing that this is the time to invest in this. Actually, one thing I didn't say at the beginning that I also find quite interesting is if you look at the kind of differential in combined ratio by the top to the bottom performers in the hard market, it's much narrower. There's much less differential. In the soft market, it's huge. So, you know, now's the time to be investing and building your framework so that when it goes into the soft times, you are much more, you have the capabilities to steer that through because that's, I think, really where the most differential can be made.
Juan de Castro: That is also something interesting. And also linking that back to your point about how we're not going to fix compensation for underwriters in this episode. But also when you were saying that you cannot link the compensation to a five-year performance until the losses develop, et cetera. The first thing that came to mind that that it is actually how compensation works in other financial markets. As a fund manager, your compensation, your bonus will be on three or five time horizon that defines the bonus.
James Anderson: Yeah, I may be talking from a place of ignorance here. Perhaps this is commonplace in the market. I don't think so, but I could be wrong.
Juan de Castro: My point is not in insurance. I think it's in another part of financial service. And the other thing is often their compensation is not so much calculated, or their performance is not calculated in absolute terms, but benchmarking it against the rest of the market. Which I think, again, would actually really align with your point about the soft market and that the performance gap really widens.
James Anderson: I completely agree. And I think it's something we do a lot, kind of going back to the same point. We've got incredible benchmark data from the London market and that sort of benchmarking, I'm not sure we do it for compensation, but that benchmarking analysis is so important. I know Lloyd’s of London also provides a lot of benchmark insights. So you definitely could do something there, but it's not my area of expertise. So I'm not aware of it if that's how it works at the moment.
Juan de Castro: Yeah it just came to mind as you were talking about some of those challenges.
James Anderson: I'm just conscious there's probably some expert in EY who’s got a hand in their mouth.
Juan de Castro: And perhaps one last question before we wrap up. So you've talked about a number of different dimensions, lots of things that insurers should be doing today to start preparing for the next cycle. Often the question is, okay, you’ve talked about the strategy, frameworks, technology, culture, where do I start? Is it defining that strategy? What is the first step?
James Anderson: That would be it for me is like carving out the time in… so much of all of our lives is in the here and now and in terms of that's burning right now, but actually, it's carving out the time to really think through how do we want to manage this and what approach do we want to take? Because all the rest sort of drops out of that in terms of thinking through your strategy, thinking through the approach you want to take, reflecting on what went well and not well in your company in the last cycle, what you'd like to do differently. And then from there, you can start to build out to, is that the problem that you had or is it more that you need to be very clear on your strategy? I think that sort of reflection of how it went, a little bit of a health check for yourself of where are we now, what are we strong and what are we weak on? And then you don't have to do all of it all at the same time, right? So it's about picking the areas that you think will drive the most value and you have the most gap.
Juan de Castro: This is a brilliant way of wrapping up the episode, it starts with at least a clear strategy, doesn't need to be a hundred-page long strategy, but it's just a clear summary of where you are where you want to be. James, it's been an absolute pleasure. I really enjoyed this chat.
James Anderson: Yeah well thank you very much for having me. I'm an avid listener so I'm very pleased to have my name on it.
Juan de Castro: Thank you so much, James. See you soon.