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Trim the ship with care

Mark Geoghegan 8 November 2016

As the third quarter results season unfolds, so the forcible separation of underwriting "men" from underwriting "boys" continues.

Necessity is making many in the market more virtuous than they have had to be in a long time.

It is great to see many practising what they have spent much of the last decade preaching.

Some are writing less and retaining a little more (because the remaining book is theoretically better stuff). Others are writing the same but retaining less. Others still write less and retain even less of that. All are perfectly valid soft market strategies.

Meanwhile, some of the best and most nimble are able to pull off the ultimate trick of still growing the top line while hanging on to less and less of what they write themselves.

This is theoretically the optimal strategy, as it means that you can remain a highly relevant, must-have supplier to your clients and brokers, but ensure that you are less exposed to the downside of lower, or indeed negative, prospective returns.

But the best theoretical plays are always the toughest to pull off in practice.

For one, your underwriting team needs not only to be significantly better than average, but must have a widely held reputation to attest to this fact, or no capital provider will be willing to take what they want to give away.

Then you have to address the new risk that you are loading onto your underwriters by changing the risk dynamics that they are working under.

To put it in marine terms, the trouble with changing the trim of the ship is that it can risk upsetting a hitherto even keel.

People say that changing the balance of retentions doesn't change behaviour, but to believe so is to discount human psychology.

If someone is sufficiently anaesthetised to feel confident that a course of action isn't going to cause them much pain, they may be willing to go ahead when they otherwise may not have done so.

The best underwriters will guard against this feeling and always write as if all third party capital were their own, but complacency and a feeling of protection is a constant danger that must be guarded against.

Also, lean operations must remember that while they may have less skin in the game, having some skin around means it still hurts when things go wrong.

Smashing half a thumb with a hammer hurts almost as much as bashing the whole one.

If an underwriter used to write close to net, but then the market softens and they take on a 50 percent quota share with a decent over-rider, they will still feel the pain if they lose their discipline.

Or they may not get burned financially, but they will get burned reputationally. And then there is always the counterparty credit risk of having so much outstanding reinsurance recoverable to worry about.

Credit risk is simply not the concern it should be in the market today.

This is always the way - credit is never a problem until it suddenly dries up.

We are currently in a credit glut, but this won't always be the case. And credit has intangible qualities that no ratings agency can put on paper. The old and wise also know that willingness to pay is as important as cash in the bank, and that slow and disputed payments can sometimes be as damaging as no payments at all.

So when trimming the ship do remember that in stormy seas, the cargo can move about considerably in the hold and that while losing ballast may save fuel, trying to go without is usually a false economy.

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This article was published as part of issue November 2016/2

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