Commercial Property - How to Stay Ahead of the Game

Competitive times are placing new challenges on Property underwriters in Asia, according to Raj Ahuja of EMB. 

These are happy days for buyers of commercial property insurance in Asia. Unlike in other parts of the world, the downward trend in rates shows no sign of abating. According to a recent survey by Aon, nearly half of buyers are seeing reductions of 10% or more this year.

For the underwriters this must, of course, mean one thing: further pressure on their margins. Not one of those questioned by Aon expected rates to rise in the immediate future, whilst many were also giving away more generous terms and conditions. A benign claims environment has gone some way to offset this trend, but only slightly. Anyone writing property insurance in Asia will have their work cut out to make a technical profit.

Faced with this challenge, how should insurers respond? It is for individual companies to decide the extent to which they are willing to chase rates down in order to maintain market share. With that qualification, underwriters should observe two basic rules: write technically; and write selectively. The market is big and it is growing and you should be able to find enough good business to stay busy without compromising your standards.

I appreciate that such advice is easy to give and much more difficult to deliver; this article will consider how to differentiate the good property risk from the bad. As in an earlier article on D&O, it is based to some extent on the painful lessons of European and North American underwriters before 2001: why they lost so much money and how it should be possible to avoid a similar fate.

Two commercial property risks can appear identical yet provide completely different levels of exposure. This is especially the case in Asia, which has an even wider range of risk management standards than in Europe or North America.

The true risk premium for a commercial property risk depends on a large number of variables, including the size of the building, the precise form of the internal and external structure, sprinklers, location, the immediate surrounding environment, hazards within a building, the quality of management and, most importantly, the uses to which it is put.

Underwriters can normally learn a lot by asking some fairly simple and obvious questions, but how many do? I know of one London underwriter who declined to cover two factories when a quick examination of their building standards showed they could not withstand a sizeable earthquake. Despite this glaring shortcoming, the broker had no difficulty in obtaining cover elsewhere in the market. Both factories were destroyed later in the year when an earthquake hit the region. Underwriting is not always a form of betting; it is an application of judgement from a solid foundation of risk awareness.

A related, if rather more technical point is that many underwriters could make much better use of their data to model commercial property risks. There are plenty of people in our business who do not think this can be done. They argue that no two large, complex risks are the same. So, whereas it is relatively easy to subject household property to modelling analysis, it is often near-impossible with large-scale industrial plants.

It may well be that you genuinely lack the data needed for modelling a really large one-off risk if you seek to compare it on a like-for-like basis. There is, however, another way. If, instead, you analyse the individual characteristics that go to make up the risk you may soon find that you are surprisingly data-rich. It is then relatively easy, using up-to-date software, to create a measurable risk profile.

Before converting this into a price you should check that your assumptions have made sufficient allowance for the possibility of a total loss. This is often omitted simply because a factory or company has never had this type of event. This absence of a big loss provides no guarantee about the future. A component pricing approach will make sure you load for all the key premium items. An important item being an appropriate allowance for reward, given the risk of the insured and the whole portfolio.

This methodology, outlined above very briefly and in simplified form, will have implications for the way that data is stored and retrieved. There may have to be changes in your back office processes, and some historic data may need to be cleaned.

You will soon find that the work more than pays for itself. This type of information, gathered over a period of years and put to full use, can provide a valuable tool for pricing the risks being accepted so that you know whether they are likely to be profitable.

Finally, a word about business interruption. 15 or so years ago it was little more than an afterthought to a standard property policy, and only very rarely the cause of big losses. Globalisation and modern production techniques have increased the likely exposure, but insurers and reinsurers are still trying to keep up with this new world. How many underwriters, for example, ask their cedants for detailed information about their supply chains, and the measures they have taken to address any weaknesses? Today this is common place in the UK market because of heavy losses suffered in the past.

Property underwriters will have little difficulty in attracting business; the challenge is to remain profitable. A bit of common sense, combined with good internal disciplines and sound technical writing, will make it much easier to spot the winners and losers. 

This article appeared in Asia Insurance Review in November 2006