Insurers risk facing big underwriting losses in the future if they fail to introduce early warning systems to ensure underwriting discipline is maintained in the scramble to utilise the new capital raised since Hurricane Katrina, warns Metapraxis, the management consultancy firm.

The $188m capital raising announced by the Catlin Group on 9 March 2006 means that since the hurricane last August, existing insurance companies and new start ups have raised over $20bn of new capital in London and Bermuda, in order to write new insurance policies.

Comments Andrew Mosely, deputy managing director of Metapraxis: “There is a danger that the industry will reach a point where capacity starts to exceed demand for insurance. If this happens and underwriters are still under pressure to write premiums they may start under-pricing policies in order to do so.”

“The pressure to win business also increases the risks of underwriters accepting looser terms and conditions in policies and not insisting on sufficient data from clients and brokers.”

“It is therefore crucial that senior managers and directors of insurance companies have the necessary systems in place to pick up any signs that their staff may be taking unacceptable risks in order to meet bonus objectives.”

Andrew Mosely explains that the senior management of insurance firms often use backward-looking indicators to monitor performance and so are only aware of lax underwriting long after policies have been written.

He says, “Most directors tend to concentrate on the Combined Operating Ratio (COR) to measure performance, which is the total of the Claims Ratio, Commission Ratio and Expense Ratio. The Claims Ratio measures the total losses incurred in a year divided by the corresponding premiums earned. The problem with this ratio is that there is a relatively long lag between when business is written and when the losses occur.”

“This means that by the time insurers realise just how soft the market has gone they may already be facing huge underwriting losses.”

Andrew Mosely adds, “Insurers need to understand what drives the performance of their business and monitor these indicators in order to predict future performance rather than simply monitor historic results.”