Michael Larrick, director at Alan Gray, explains that diagnostic studies of underwriting, claim and distribution systems that can minimise post-transaction surprises arising from target insurers and reinsurers.

A carrier's profile provides basic insight regarding the nature and extent of focused due diligence that will materially enhance predictability of problems and unexpected liabilities. Examples of other inquiry areas are listed below.

An insurer with a mature, stable, book limited to core business is ordinarily not a candidate for in-depth diagnostics. However, with the exception of niche players (eg. title insurance), few carriers are content with a status quo long-term business plan.

Marketplace pressures along with the ever-present demands for innovation and growth can significantly change an insurer's dynamics and volatility. As carriers venture outside of core competencies, management may underestimate challenges and risks. Moreover, the very individuals who should candidly evaluate new concepts in light of current capabilities often remain silent for fear of displaying technical weaknesses. Insurers' experience with financial guarantees vividly illustrates this phenomenon. Accordingly, “new” undertakings, outsourcing or other changes may warrant special attention.

Indicators of the need for diagnostic review of underwriting, claim or operational units include:

● Run-off or current business which represents a significant departure from core competencies
● Exposure to “newer” classes of latent claims such as lead paint and pigment and chemicals
● Increased reliance upon external service providers such as MGAs, TPAs, and policyholder service providers
● Activities likely to draw regulatory scrutiny such as acquisition of books of business or the underwriting of lines laced with consumer issues (eg. long term care and warranties)
● Assimilation of service obligations outside an organization's core competencies (eg. non-standard business such as aggregate excess coverage)
● Expansion or contraction of operating territories
● Fraud management and cost containment capabilities that are substandard in comparison with peers
● Case reserve philosophies and/or practices which significantly depart from industry standards
● Substandard compliance (market conduct) controls or poor performance in consumer complaint rankings
● Growing acrimony with reinsurers or retrocessionaires.

Sound analysis during the due diligence phase includes assessment of the overlap and interrelationship among attributes. It's important to have diagnostic studies performed by professionals who do not have to surmount a learning curve in order to evaluate vulnerability or potential liability. Lastly, market conduct is an important but often overlooked area which can impact on an insurer's future liabilities and goodwill value.

This Feature item appeared in issue 112 of JTW News - February 2007

Author: Michael Larrick - Alan Gray