Risk-Based Underwriting

Insurance companies today are grappling with changing and emerging perils, and their underwriting approach in homeowners’ lines is changing accordingly.

As water damage becomes the pre-eminent peril facing homeowners (replacing fire as the Number 1 source of insurers’ claims payouts in homeowners’ lines), brokers and consumers can expect to hear a lot more about a new underwriting approach dubbed ‘risk-based underwriting.’

Simply stated, risk-based underwriting is a more granular, specific way of assessing typical exposures covered by a comprehensive homeowners’ policy — water, fire and theft.

“When we are talking of risk-based underwriting, the intent is to refine the segmentation in the pricing or underwriting rather than looking at [generic] profiles in which all kinds of risks are bundled together,” says Martin Beaulieu, senior vice president of personal lines for Intact Insurance.

Using risk-based underwriting, for example, companies will re-examine their homeowners’ book of business to assess how specific perils might affect a consumer’s risk profile. “We can look at what the fire risk is, what the water risk and what the theft risk is, and that’s where I think it’s important to refine the segmentation,” said Beaulieu. “It could be that each of these perils is moving in a different direction. So a single [homeowners’ risk] profile could be mov- ing in one direction for water, and in another direction for fire, but at the moment it’s all defined as a big package. I think if we’re looking at that as a big bundle, we’re not providing the insured information as to what is their biggest exposure and how they can mitigate that risk. We’re starting to do that. The way we’ve done it is that our pricing is segmented by peril, but in the end we’re coming back with one premium.”

DATA COLLECTORS

One upshot of this segmented approach is that insurers are amassing as much detailed information as they can relating to their homeowners’ books of business.

“We’ve looked at our data historically, which is typically what actuaries would like to do, to project the future,” said Bob Fitzgerald, executive vice president and chief marketing and underwriting officer at Aviva Canada. “But we’ve also pulled into play a number of other sources of information that can help disaggregate the pricing of a personal property exposure. If you break [an aggregate profile] down and then build it back up by taking the inputs from various sources, you can get, in our view, a much more granular, more accurate reflection of the exposure without having to group risks in the thousands.”

These various data inputs can get quite specific. In the area of water losses, for example, insurers are collecting refined data related to sewer zones. They are collecting data from municipalities on the age and nature of their infrastructure, including sophisticated mapping of the size and age of piping in specific areas.

Although the escalating number of water damage claims has prompted insurers to reconsider how they are underwriting risk in personal property lines, the risk-based approach relates as well to other specific perils such as fire and theft. For example, insurers are collecting data intended to answer questions such as: are theft patterns consistent across geographic areas? What triggers theft? Are theft patterns different depending on whether the stolen items are on or off premises? Is all theft equal?

Collecting more — and increasingly specific — data is intended to provide insurers a much more nuanced perspective on the risks in their homeowners’ books of business. “It’s almost like DNA [analysis],” says Fitzgerald. “It’s like looking at de-coding the genome, looking at what’s really going on in property, and then finding creative ways to provide attractive solutions to customers and brokers.”

The new underwriting trend might even lead the industry in the direction of creating new, more specific insurance products down the road. “To my mind, a peril-based approach is about offering coverage for fire, offering coverage for theft, offering coverage for water damage and being specific about that,” says Mike Wallace, vice president of risk underwriting and reinsurance at RSA. “It’s probably having different rates and different segmentation for each one of those…

“There is no water product, per se, but I think we are going to have to work with all of the industry bodies to come up with some agreement as to how that would look. In the meantime, you can look at segmenting your own product a bit differently.”

THE PRICE IS RIGHT

Obviously a much more nuanced underwriting approach could be expected to result in a much more nuanced approach to pricing as well. Assuming that insurers collect enough information to give them a more accurate portrayal of the exposure at a granular level, one can assume the data would help them narrow down to the point when they can almost price for a specific location and/or peril.

Still, it’s somewhat up in the air as to how a more nuanced underwriting approach would affect a policyholder’s bank balance. Some consumers might receive a break on their premiums, based on a more specific assessment of their risks. Others might not be so lucky. “We want to provide value to customers, provide value to brokers,” said Fitzgerald. “That’s not necessarily saying we are going to have a great price for everybody, but having the right price.”

Certainly brokers will want to know how that “right” price is derived. And this goes to the heart of what insurers might argue is a necessary level of opaqueness related to the molecular level of risk-based underwriting. Insurers competing with each other at the level of data segmentation are loath to tip off their competitors about how risk-based underwriting helps determine specific pricing. “It’s the secret sauce argument,” said Fitzgerald. “Does Coke tell Pepsi what they are doing? Absolutely not.” Still, Fitzgerald supports an ongoing dialogue within the industry about what level of transparency is required. “It’s important for companies to be able to articulate at a high level the kinds of things that are influencing the customer proposition that’s being put forward, without getting into the granular… without saying how Cadbury puts the filling in the Caramilk bar,” he said.

RISK MITIGATION

While a segmented analysis of risks or perils might not necessarily or directly translate into lower premiums for consumers, it might indirectly achieve the same result, insurers note. That’s because the same data underlying the underwriting approach can also point towards improved loss control and mitigation techniques. For example, in keeping with the concept of risk-based underwriting, insurers can advise policyholders living in an area at a high risk for water damage on how they can be more aggressive in mitigating water damage to their homes. A number of new technologies — including backwater valves, water detection sensors and automatic water shut-off devices — can be installed to reduce water damage inside the home.

“It’s prudent to look at all of the exposures and protections and all of the activity that companies and insureds take to try and mitigate loss, and then give them an appropriate credit on their policy,” says Paul Johnstone, vice president of personal insurance at Chubb Insurance Company of Canada. “We’ve taken a step further. It’s a relatively new initiative at Chubb. When we have certain types of water-related losses, we actually provide funds in the claims settlement process to pro-actively post-loss install water-detection devices so that we can prevent future losses.”

There are other ways to modify the product to account for more specific data, says Wallace. For example, insurance companies can put limits on coverage for sewer back-up. They could introduce higher deductibles for water damage, or so-called “water deductibles.” And they could start legal action against some of the manufacturers of produc ts responsible for water damage inside the home. “When we talk about inside water, one of the things we’ll be looking at more closely is subrogation against some of the manufacturers of these [products], washers and dryers, for example,” says Wallace. “We haven’t done that much in the past, where a dryer or washer may fail under a warranty period. You do have an opportunity to go back and subrogate against them.”