UNDERWRITING AUDIT OVERVIEW By Carl A. Fuchs

ABOUT NORTHPORT FINANCIAL UNDERWRITING REVIEWS

Northport Financial provides a wide range of underwriting and insurance related services. One of these services is conducting underwriting reviews for our clients. Northport is engaged by insurers and reinsurers for due diligence evaluations on potential new business, audit existing programs and conduct runoff reviews. These review teams deliver detailed analysis and recommendations to our clients through an objective, disciplined assessment of underwriting files.

Following an underwriting audit, the management of each facility reviewed is provided with a wrap-up discussion regarding the conduct of the audit. A written report is provided to the client carrier outlining the key findings of the review, identifies the facilities strengths, and offers specific recommendations intended to assist the client in improving its underwriting effectiveness.

Underwriting reviews are conducted using a consistent objective format tailored to the carrier’s requirements. Each account is measured against a set of pre-established criteria and consolidated for all accounts reviewed. Typically, Northport resources are used in conjunction with a client carrier’s underwriting review team.

Northport’s underwriting review teams are composed of insurance professionals with property and casualty underwriting experience. Team members have experience with a varied client base including insurance and reinsurance carriers that specialize in writing small commercial, middle market or large national accounts. Collectively, Northport team members have more than 150 years of industry experience in most lines of commercial insurance. Review team members backgrounds include underwriting, underwriting management, profit center management and product development for domestic and international primary carriers and reinsurers.

From its inception in 2002 through 2009, the Northport underwriting review teams have conducted more than 250 property and casualty program file reviews. These included general liability, automobile, commercial package, umbrella, workers’ compensation and professional liability. Many reviews included more than one line of business.

RECURRING AUDIT OBSERVATIONS

Based on the reviews conducted by Northport, there are a number of issues that are frequently identified on audits conducted.  These can be summarized as follows:

Operations and Exposure Analysis

The key issue of the underwriting review process is the need to verify that the underwriter evaluated and analyzed all key information about a risk before deciding to include the account in a program.  Files often lack sufficient evidence that the underwriter made full use of the information available.

The size and complexity of an account will determine the amount of underwriting required to analyze the operations and the potential for loss.

In some cases, the reviews Northport conducted found accounts lacked a description of what was the insured’s business involved.  Package policies often focused on property exposures and did not always fully document loss potential from the liability exposures.  Underwriting for small fleets was often limited to a list of the covered vehicles and drivers, with a limited analysis of driver controls and how the vehicles were used.

Some additional areas noted that are not often completely documented in the files by the underwriter included:

• Insured Operations – Incomplete documentation and evaluation of information on the company’s size by comparing payroll, annual receipts or employees; time in business and details on the insured’s services, products or operations.  It was noted that the use of supplemental applications, web sites and loss control inspections assisted the underwriter in identifying exposures.
• Insured entities - Identification and analysis of the named insured as well as additional named insureds.  Additional insured endorsements, particularly for manufacturers, vendors, contractors and subcontractors did not always receive the attention and analysis required.
• Automobile exposures - Exposure analysis needed to include vehicle type, radius of operations, hiring practices and driver controls. Trucks incorrectly classified as to weight and radius of operations lead to an inadequate premiums.

Effective Use Of Loss Control

Inadequate loss control was an area frequently cited as an area needing improvement.  In these cases, loss control reports were not obtained for accounts with substantial exposures or the reports obtained did not adequately address information required to underwrite the account.  Missing information included the covered operations, controls and existing safety programs.

Although some smaller risks were written without a formal inspection or loss control report, a full loss control report should be required for accounts with more complex exposures including contractors and truckers.

The carrier and underwriting facility should develop loss control guidelines for use by the underwriting facility or for reference by fee companies to ensure the inspections adequately address all exposures.

Depending on account size obtaining loss control reports is not always feasible or cost effective, but it is important to obtain inspection reports on a timely basis for those accounts meeting the inspection criteria.  When inspection reports are received, the file should document the underwriter’s review of the report.  It is also important that underwriters address discrepancies between the application and the loss control report and take necessary action as appropriate.  Reports should be updated on a scheduled basis depending on the program requirements.

Applications and Account Information - Obtaining Sufficient Current Underwriting Data to Properly Evaluate Exposures.

A standard application frequently lacks the full detail of an insured’s operations and controls necessary for an underwriter to make an informed decision regarding the desirability of a risk.  Reviews conducted by Northport found that accounts underwritten did not always have sufficient information to properly assess operations, hazards and controls or lacked updated renewal information.

To thoroughly evaluate an account’s operations and controls, an underwriter should collect enough underwriting information to assess the account’s exposure to loss and hazards.  The amount of information required to properly underwrite an account varies based on the size and type of operation, but in all cases applications and other supplemental data should be updated regularly to ensure that the underwriter is aware of potential exposure changes during the policy year.

The use of supplemental applications designed specifically for a particular class of business such as contractors, truckers, apartments, restaurants or professional exposures should be employed in addition to the standard ACORD applications.  In addition, other sources of additional underwriting information should be included such as web sites, financials, and workers compensation experience modification worksheets to confirm correct classifications, payrolls and loss history.

Automobile supplemental information should include a current drivers list and evidence that the underwriter has reviewed and addressed any drivers who fail to meet the program’s driver criteria.  Personal use of covered autos should be addressed.  Fleets should include guidelines on hiring practices, driver controls and vehicle maintenance.  Tools available for trucking accounts include SAFER Reports, motor carrier filing information and state fuel tax records.

Documentation of The Pricing Process

Poor documentation on pricing rationale generated a significant amount of Northport’s suggestions for improvement and audit recommendations.  The primary issue leading to a recommendation was the failure to document judgmental pricing, primarily schedule rating.  Underwriters should provide a brief statement outlining the underwriter’s rationale when pricing an account.  The files need to document the connection between the price charged and the relative account quality based on the documented exposures and controls in place.

Poor pricing documentation examples included:

• Final pricing with weak underwriting rationale that does not reflect the risk quality as evidenced by exposures, loss control evaluation and risk controls.  
• Pricing decisions based solely on competitive pressures without recognition of the quality of the risk or if the final pricing was adequate for the exposure.
• Lack of rating worksheets or differences in the rating worksheets and the premiums shown on the policy.
• Poor management of pricing trends in the rate-to exposure for both individual accounts and the book as a whole.

Use of historical loss information to evaluate risk quality

There were a number of instances indicating a need to improve development and analysis of prior loss information.  Information on the prior loss history should be required for accounts.  In the case of smaller, low hazard accounts where loss frequency is not expected, a loss summary as part of the application may be acceptable. For larger accounts and risks where loss frequency or severity is anticipated, currently valued loss runs from prior carriers in hard copy should be required.  A year-by-year summary of premiums and losses should also be part of the underwriting file.  Loss analysis should include evaluation of trends or patterns as well as the details of any larger incidents.  Unusual losses or causes of loss that appear to be inconsistent with the operations also require additional review and documentation.  

Account Management and Interim Underwriting Actions

Northport noted programs where the initial underwriting was satisfactory, but management of the individual account during the policy period was inadequate. 

Examples of effective account management weaknesses included:

• An inconsistent approach to monitoring compliance with loss control recommendations
• Lack of effort to resolve discrepancies between the application and loss control reports, the insured’s web site or other sources of information
• No follow-up on missing driver information or unsatisfactory drivers
• Poor adherence to regulatory-mandated time frames for cancellation or non-renewal.  Lack of attention to these requirements often leads to an insurer forced to remain on an undesirable risk

CHARACTERISTICS OF SUCCESSFUL PROGRAMS

After reviewing a broad range of programs composed of different lines of business, exposures, and underwriting appetites, Northport found most successful programs had the following characteristics:

• Securing complete submissions. Submissions contained detailed information about the risk including supplemental applications, web sites and company brochures.  The development of complete and accurate information enabled informed decisions regarding risk and hazard acceptability.
• Development of historical loss history.  Prior carrier loss data was obtained on each account.  This information was used to analyze the types and causes of past losses.  The assessment of losses addressed the causes of large claims, identified frequency trends, and took into account the extent of current coverage.
• Effective use of loss control.  Inspection reports addressed all operations, had details on both common and unusual hazards and included photos and diagrams when applicable.  Underwriters reviewed loss control reports and documented their analysis.  Guidelines were in place to determine when loss control reports are to be ordered and updated.
• The consistent use of account summary forms by underwriters to outline their risk assessments and overall thought process. The forms included space for the underwriter to provide a description of the key operations, exposures and existing controls and a summary of the loss analysis.  The summary also included a brief statement outlining the pricing of the account with documentation that tied the risk characteristics and exposures into the pricing decision.  The account summary form served as a working document for the current underwriter as well as a starting point for the next renewal.
• Design and implementation of clear authority guidelines and referral procedures.  Consistent documentation on referrals when required.
• Established management processes to perform regular internal file reviews ensuring that individual underwriters are consistently following the company’s established underwriting and pricing procedures and adhering to risk selection guidelines.
• Regular evaluation of pricing trends and comparison of changes in rate-to-exposure.

Northport works closely with both carriers and their underwriting facilities in a process that benefits both parties.  Our goal is to confirm the underwriting strengths of the carrier’s underwriting facility and to insure that policies, procedures and processes are clearly defined.  Our reviews identify areas of improvement and assist the carrier to provide products and services needed for a successful program.

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IT’S YOUR PROGRAM. IT’S YOUR AUDIT. TALK IT UP! By Raymond Williams, Jr.

Managing General Agents (MGAs) produce hundreds of millions of premium dollars annually. Insurance and reinsurance companies rely on the expertise and efficiencies of MGAs to underwrite and produce target books of business on their behalf. Company directed audits are an industry practice critical to management of the MGA relationship. Depending on the carrier, there can be a wide divergence in the approach to and philosophy of conducting audits. Ultimately, the common denominator is that delegating authority mandates conducting audits. The extent and nature of the audit process is usually defined by the company’s own business practices (including Sarbanes Oxley criteria) and state regulation, with New York’s Regulation 120 often referred to as a common guide.

A low priority on the list of reasons for conducting audits is their effectiveness as a two way communication opportunity. Given proper time, preparation and frequency, audits can significantly improve communication between the carrier and MGA and ultimately contribute to above average program performance. Generally, both sides of the MGA relationship espouse the communication benefits expected from audits. In practice, audits are often conducted around other responsibilities and primarily directed at the review of controls and guideline compliance as well as satisfying the company’s need for written audit documentation. These are valid and extremely important elements of the audit process. However, given the complexity and long-term nature of MGA strategies, the importance of communication and information sharing during the audit process should not be understated. The MGAs and partner carriers that outperform the market understand this.

In conducting nearly two hundred audits and due diligence reviews during the last six years, we have found that most successful MGA relationships are partnerships built upon mutually beneficial long-term goals. Parties are genuinely interested in working together to achieve stated objectives. Our experience indicates that quality MGA relationships can be traced to a limited number of factors.

Well designed and documented contracts govern management of the agency relationship. This partially reflects the carriers’ abilities to learn from past experience (theirs or others) and expanded regulation. New York’s amended Regulation 120 is a case in point where regulation has sought to better define roles and responsibilities. Company protocols usually require a standard agreement structure and that a fully executed agreement be in place before a program can be launched.

The level of MGA sophistication has evolved during the last decade. Today’s successful MGAs:

• View the relationship with the carrier(s) as a partnership and bring a long-term perspective to their program, often sharing in the risk not just because it is required to place the program but because they believe in their own performance;
• Control their data (exposure, premiums and losses) and can speak to individual account underwriting activity and to portfolio results. These organizations maintain information on their book independent from their carriers who in some cases have gone into runoff;
• Recognize that the aggressive pursuit of technology does not just provide competitive advantages but is critical to long-term survival. They understand the need for greater efficiencies and the ability to recognize change. They can analyze trends in the book and in the marketplace at an increasingly faster pace.

So if, in the aggregate, the Managing General Agents of the new millennium are the improved breed as a result of a natural selection process that would warm the heart of Charles Darwin, why aren’t all program underwriters basking in the results of sub 100% combined ratios? Various factors are usually referenced with pricing being cited most often. Agents routinely identify the rate discounts being deployed by their competitors.

A distinguishing performance factor that is hard to quantify is the quality of communication between the agency underwriting team and the company’s program manager. When we conduct audits, we evaluate the entire underwriting process. By definition this includes the form and quality of interaction and communication between the MGA and the carrier. Successful performance is critically dependent upon this communication and there are numerous places that can positively or negatively impact communication including underwriting guidelines, judgment rating, referrals, claims handling, loss control activity, and audits. We routinely find that audits have the potential to be one of the most important communication activities of the underwriting process. There is no substitute for on-site interaction between the company’s underwriting representative and the agency’s day-to-day underwriting staff.

For example, one of the more routine communication gaps that we see involves underwriting guidelines compliance. As previously noted the MGA agreement often effectively defines contractual responsibilities and expresses the intent of the parties on a book of business basis. The details for managing the day-to-day activities supporting those objectives usually reside in documents such as underwriting guidelines and letters of authority. As an independent party, we evaluate the underwriting performance within the context of such guidelines and authority grants. We often find that, good intentions notwithstanding, there may be different interpretations of tasks and responsibilities outlined in these documents. The original author of the documents may feel that clear direction has been provided but individuals involved in the day-to-day implementation may be operating with different interpretations. On-site reviews of files often highlight interpretational differences between actual practice and guideline intent. Detecting such differences may be delayed with a limited audit schedule.

We recommend that audit objectives and protocols assign greater emphasis to the exchange of information during the audit process. Working from the premise that most MGA relationships are based on a strong partnership approach, all parties might consider the following as part of the audit protocol:

• Value the MGA underwriters as the decision makers at the point of sale. Initiate discussions with them to address specifically identified audit objectives and to solicit their input regarding what they see going on from their desk.
• File review analysis should routinely include “tests” of the applicability of inforce guidelines and trigger guideline changes to address both the current and projected business environment, as needed.
• Exchange information on the dynamics of the target industry or market segment. Invest time anticipating the breadth of impact that the economic environment may have on underwriting results.
• Spend time trying to understand the competitive environment. Appreciate the fact that the MGA’s assessment is subject to their specific focus while the company’s underwriting representative can bring a broader market perspective to the discussion.
• Review a sample of referral files to evaluate the quality of information contained in the referral compared to information available in the file. It may reveal ways to improve the referral process. Evaluate the clarity of direction provided by the authorizing underwriter.
• The audit schedule should reflect the amount of authority and responsibility that has been delegated. The cost of the audit in time and resources may be minor compared to the limits and premiums that are being managed on a daily basis. Regular and frequent audits improve communication.

Today’s insurance industry is more dynamic than ever. The successful audit process recognizes the importance of communication and cultivates an exchange of ideas that may lead to alternative strategies. It’s your program. It’s your results. Talk it up.

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