Depending on which side of the fence you live on you either see underwriters as the scourge of the industry because they get in the way of your producing business or they are the saviors of the industry because they are the gatekeepers protecting the company from risk. This has been an age old battle and frankly I’ve always seen it as beneficial, helping to make sure that insurance companies write as much good business as they can get their hands on. If producers want to write everything and underwriters don’t want to write anything then somewhere in between is a healthy balance that allows for something to be written profitably.
The compromise that a risk underwriter can strike with a producer when considering an application for insurance is predicated on the theory of large numbers and the recognition that over a large enough book of business and time that a measured approach to risk consideration will yield profit. Sometimes they will get it right and sometimes they will get it completely wrong, but on average it will work out. Risk underwriters are allowed to make a certain number of mistakes and still be seen as successful.
There is a new underwriting Sheriff in town now and this one isn’t allowed to get it wrong, ever, and its causing a lot of consternation in the alternative risk and captive insurance arenas. Credit underwriting has long been like a camel poking its nose under the traditional insurance tent. Granted, there is a correlation between credit worthiness and risk quality and it should be considered as one of the underwriting criteria, but because of the current financial crisis it has taken on a life of its own particularly in risk sensitive programs.
In large deductible and captive insurance programs the insurance company providing coverages must consider the credit worthiness of the risk taker as a part of the overall risk they are assuming. These risk transfer programs have elements of both underwriting and credit risk. Balancing the underwriting of risk has been dealt with effectively over the years by recognizing that if you prudently insure a large enough pool of risk that you will end up winning over time and making a profit.
Credit risk is still a relatively new stand alone discipline and as a result it is still trying to get its footing on what has been a slippery economic slope. Unlike their risk underwriting associates, credit underwriters don’t have the flexibility to get it wrong. Credit underwriting to this standard would be like a risk underwriter looking for loss picks in the 90% actuarial range. It stops being a pooling mechanism at that level and the client might as well completely self insure. Combine this with the enhanced regulatory and compliance environment that we find ourselves in and we have a big problem when it comes to deductible and captive insurance programs. Rather than assume a measured degree of credit risk this new breed of underwriter is seeking full collateralization of every deal. Its a bit like the joke that a banker won’t loan you money until you can prove that you really don’t need it.
The solution to this problem is for insurance credit underwriters to embrace the theory of large numbers and to recognize that they can assume a measured degree of risk and on an overall book of business end up being whole. They, and their managers, must be willing to accept some degree of loss as a part of their cost of doing business. Until that happens alternative risk program development will languish for all except those that don’t really need it!