Underwriting in a Hard Market: Where the Winners Emerge

In many segments of P&C insurance, the industry is going through what is known as a "hard market" in which prices are high and underwriting capacity is scarce. These conditions are due to many simultaneous challenges: economic inflation, financial volatility, unexpectedly high jury awards, expensive reinsurance, and more frequent natural catastrophes.

This sounds bad, but it really isn’t. The P&C industry is a cyclical business, and it has been in hard markets before. Each of these hard market cycles had different underlying drivers (see top 10 list below), but the outcomes were similar. The industry went through a tough "shake-out" where the weaker players were forced into receivership, and it emerged stronger than before with many lessons learned.

During these hard market cycles, most insurers react defensively by raising prices, tightening underwriting guidelines, trimming underperforming renewals, and exiting unprofitable segments. But there are a few contrarian insurers who do the opposite.

These contrarians simply embrace the market volatility. They deploy fresh capital to distressed segments, capture market share at attractively high prices and, if things go well, they make outsize underwriting profits.

Historically, contrarian insurers have done well. In the 1980s, insurers with underwriting discipline embraced the opportunities (holding onto premium for a 17% interest rate, for example) while avoiding the pitfalls (asbestos and hazardous chemical liability exposure). After the 9/11/2001 terrorist attacks in the United States, many insurers stopped writing terrorism coverage while risk-taking insurers continued to write it and were rewarded handsomely with elevated property CAT pricing for an extended period. In 2004-2005 after a spate of hurricane activity, many Bermuda upstarts made outsize profits by addressing the shortage of reinsurance capacity. Today in 2023, our market challenges will be solved by a small, advanced cohort of insurers who move fast, underwrite with discipline, and "see around corners" on fast-moving market trends.

Capital availability challenges: Top 10 most expensive P&C events

These insurers will be the top performers in our current hard market. There are six behaviors that will characterize their underwriting desks:

1. Granular pricing. In both commercial and personal lines underwriting, risks will be priced according to their true exposure across dozens of highly specific characteristics. For example, UK quote aggregators are sometimes known to differentiate the price of their quotes based on an applicant's email address (i.e., Gmail vs. Outlook). Why? Because actuaries did the back-testing and found convincing results in loss performance.

2. Strong focus on renewals. In normal times, the "renewal underwriter" is a junior-level role and relatively little attention is paid to the process. But during these challenging times, great attention will be paid to whether a policyholder may be 'worthy' of an insurer's capacity. Renewal applicants with poor loss experience will find themselves shopping.

3. Micro-segmentation of the market. Hard market winners will identify the exact portion of the market they wish to target and divide it into small homogenous populations. Each population will receive its own strategy, pricing, coverage, distribution... and sometimes even claims and loss control services.

4. Effective distribution that doesn't cost an arm and a leg. Insurance distribution has gotten very sophisticated in the last decade, and today we live in an exciting multichannel world where a policy can be bought virtually anywhere. But insurance distribution is expensive, costing up to 25% of premium. The high performing insurer will find channels that maximize their ability to pounce on market opportunities without overpaying for the privilege.

5. Fast, agile opportunism. P&C Insurance is a conservative industry, and rightfully so. It has thrived for more than 300 years by evaluating risk prudently, with a longer-term outlook than most industries. But the nature of risk is changing exponentially faster than it did 10-20 years ago. With this acceleration comes opportunity. A small number of insurers willing to ignore the crowd, lean into their information edge, and move decisively will reap outsize rewards during this market cycle.

When this difficult part of the market cycle is over, how do we identify who the winners are? The single best metric to use is a multi-year return on equity, which considers an insurer's profitability alongside its use of 'underwriting leverage' (high premiums relative to surplus) to further amplify its gains. From 2018-2022 the ROE leaders significantly outperformed their peers.

At Guidewire we are committed to helping our customers outperform the market and we’ve made an unprecedented investment into R&D to make it happen: Guidewire Cloud offers a robust AI/ML platform to build and operationalize predictive analytics; a cyber data listening engine to quantify and price cyber risk; and an underwriting data catalog to deliver relevant, accurate, and predictive information to underwriters and actuaries in milliseconds.

We believe that in the next five years a new cohort of insurers will stand out because of their superior performance, driven almost entirely by underwriting ability. This cohort will swiftly capture market share during the opportune moments that a hard market affords.