IFRS

1. IFRS Derek Bain Director of Actuarial Services AXA Ireland The Underwriting Cycle 2008 Rising to the Challenge The Insurance Institute of Ireland, Wednesday 26th November 2008 Ballsbridge Court Hotel

2. 1st Annual CPD Conference 2008 Managing Claims Costs Motor underwriting performance 1977 - 2007

3. 1st Annual CPD Conference 2008 Managing Claims Costs Why do we have cycles ? • Uncertainty surrounding the true cost of claims at the time business is written which leads to…. • Use of revenue year metrics as proxies for true underlying account performance. • Potential problems with new entrants/rapid growers. • Over focus on market share/premium income measure with a corresponding downgrading of economic return metrics. • Over reaction to good news – Under reaction to bad news. • Fear of being different.

4. 1st Annual CPD Conference 2008 Managing Claims Costs 1. Uncertainty surrounding the true cost of claims At the end of the year in which you wrote the business only 30% of claims are settled.

5. 1st Annual CPD Conference 2008 Managing Claims Costs Uncertainty surrounding the true cost of claims • When we come to reviewing the profitability of an accident year only 30% of our claims have been settled. 70% are exposed to future events such as • Claims inflation, Changing legalisation, Future medical advancements, Etc. • When it comes to assessing the profitability of the business written last year the situation is much worse as 50% of the premium has yet to be exposed to risk. So it’s exposed to all of the above plus • Changing road safety standards (good and bad), Changing frequency levels, Economic climate, Weather ,Etc.

6. 1st Annual CPD Conference 2008 Managing Claims Costs Uncertainty surrounding the true cost of claims • Position is even worse when there is a major change in the external environment (and we’ve had lots of these recently). • We need to be very careful when interpreting data. Apparent reduction in average settled cost is completely false

7. 1st Annual CPD Conference 2008 Managing Claims Costs Uncertainty surrounding the true cost of claims • Accounting for uncertainty is difficult ! • It leads to over and under estimates of performance. • Accounting solution is to focus on revenue year accounting. • Not a problem as long as you remember that the current revenue year performance can has ALMOST NOTHING to do with the performance of the business you wrote during the last 12 months. • Major problems arise when there is a confusion between performance on a revenue year basis and on an accident year basis.

8. 1st Annual CPD Conference 2008 Managing Claims Costs Market performance – Let’s focus on the more recent revenue years

9. 1st Annual CPD Conference 2008 Managing Claims Costs What’s happened to premium over the period Strong profits coupled with low premiums – Have we reached Nirvana ?

10. 1st Annual CPD Conference 2008 Managing Claims Costs Is all this sustainable ? – Let’s take an accident year perspective The underwriting/trading result lags the accident year result – We’ve been loosing money for the last 2 years.

11. 1st Annual CPD Conference 2008 Managing Claims Costs Claims releases bridge the gap How much longer is this sustainable ?

12. 1st Annual CPD Conference 2008 Managing Claims Costs Uncertainty surrounding the true cost of claims – Problems for new entrants and rapid growers • As the true manufacturing cost of a policy written today will not be known for several years it’s vitally important that appropriate metrics are used to measure business performance • If it’s difficult for an established player in a steady state position to forecast claims costs imagine how hard it is for a new entrant or rapidly growing company to do so. • New entrants often come in following several years of positive results but get in too late and write loss making business. It can take a while before they realise their mistake.

13. 1st Annual CPD Conference 2008 Managing Claims Costs 2. Over focus on market share • Targets are nearly always based on premium income. • Growth targets are often unrealistically high. • Generally only one plan prepared – what you do next year should vary depending on what happens to external factors. • There needs to be much more focus on economic breakeven combined ratios and underlying earnings. • There is generally no recognition of the existence of cycles when plans are prepared. If there was we would plan for a loss in market share as rates become unprofitable.

14. 1st Annual CPD Conference 2008 Managing Claims Costs 3. Over reaction to good news • All good news is factored in immediately. Bad news only gets included after it has happened. • Assuming 0% claims inflation because that’s what happened last year. • Assuming a continuation of a favourable trend rather than a flattening or a reversal. • Excluding “extraordinary” events from pricing on the assumption they will never happen again. • Pricing to breakeven on a good year (and consequently loosing money on the bad ones). • If a risk has had a good year it’ll have another one next year. If it’s had a bad year it will correct itself next year.

15. 1st Annual CPD Conference 2008 Managing Claims Costs 3. Eventual over reaction to bad news • By the time bad news gets factored in we usually have had a couple of loss making years. This often leads to an pressure on reserve levels as these unprofitable years may be inadequately reserved. • The combination of inadequately priced business coupled with reserve pressure leads to an over-correction in rates as companies attempt to correct current year profitability and shore up reserves. • The reserving problem can be particularly severe if the bad news affects all outstanding claims and not just the last couple of underwriting years (such as a step change in claims inflation as happened in the mid 90’s).

16. 1st Annual CPD Conference 2008 Managing Claims Costs 3. Eventual over reaction to bad news

17. 1st Annual CPD Conference 2008 Managing Claims Costs 4. Fear of being different • Your view of the future cost of claims is a combination of • your own data • The manufacturing cost implied by competitor rates. • When your view is out of line with the market there is a natural tendency to question your own assumptions and place more weight on the market view. • This problem is exacerbated by rapidly changing external factors and a lack of reliable external data. • Sometimes its hard to believe how irrational everybody else seems to be. They are all clever people so isn’t it more likely that your wrong ?

18. 1st Annual CPD Conference 2008 Managing Claims Costs 4. Fear of being different • The cycle lasts several years so you need to remain strong for a long time before your proven right. • Active cycle management requires you to shrink as the cycle moves down – not many companies allow plans with falling volumes. • A better strategy comes from • Rapid expansion during the over priced phase (geometric growth) • Slow decline in volume as prices drop.

19. 1st Annual CPD Conference 2008 Managing Claims Costs Underwriting Cycle – So what ? • Markets love stable earnings. Cycles destroy value as they reduce the perceived value of your income stream. • Diversification by line can help but lines are often more highly correlated than people think. • Active cycle management can help an entity maximise its value. • Focus on economic indicators rather than reliance on “accounting” measures will help inform managements decision making process. • Sometimes you just can’t grow profitably !!!