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The strategic CRO and the balance of risk and capital

Insurance Consulting and Technology
Insurer Solutions

By Dave Ingram | December 18, 2019

The strategic CRO needs to be prepared to talk about balancing in planning discussions.

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About our 'A Year in the Life of the Strategic CRO' series

In our ongoing A Year in the Life of the Strategic CRO series, risk experts from our Insurance Consulting and Technology team, Willis Re and other parts of Willis Towers Watson cover how a strategically focused CRO can drive corporate strategy through the enterprise risk management planning process and throughout the year.

Most companies, if asked, can tell you their risk trajectory — the relationship between their plans for growth of risk and capital. When we asked, about 60% of insurers said that their risk trajectory is to keep their growth of risk and capital in balance.

Some insurers are in a strengthening mode, where they need capital to grow faster than risk, while others are on an expansion course with risk planned to grow faster than capital. Interestingly, when we look at results, only about 30% of insurers have achieved that balance. Some missed due to unexpected losses that resulted in decreases to surplus while business grew, and others because growth was unexpectedly higher than planned.

RBC ratio on the Y-axis and and year on the X-axis
Figure 1: 10-year RBC ratio history

Business grows faster than surplus

RBC ratio on the Y-axis and and year on the X-axis
Figure 2: 10-year RBC ratio history

Two more scenarios

Given this dynamic, the strategic CRO needs to be prepared to talk about balancing in planning discussions. They may know going in that balancing will not be the target risk trajectory for their firm, but, understanding the parameters of a balanced risk trajectory and being able to contrast those with company plans, should be a valuable conversation. Even if an insurer is not now expecting to be in a balancing situation, it will need to transition to a balance at some point in the future. In those situations, the strategic CRO can convey the differences in growth and/or earnings that will be needed to support future balance.

Balance comes when the profits from the business result in a growth of surplus that is similar to the growth of business. This means that the CRO of a property and casualty (P&C) or health insurer can approximately determine the target combined ratio for their business based upon the expected earnings on their invested assets and the expected growth of their premiums. For a life Insurer, the CRO can determine the spread on customer funds given the growth of business (net sales and lapses) and the earnings on investments backing surplus and expected profits/losses from insurance and expense margins.

Balancing now

When the expected objective is balancing, there are several subjects that the strategic CRO might address. First is the current (or recent past) deviation from balance, if one exists. That means first identifying the magnitude of the deviations of earnings and/or growth leading to a possibly difficult question:

Do we want to bring surplus and business back into the balance that was expected before the deviation, or not? If so, over what time period? This is difficult if the deviation caused risk to grow significantly faster than surplus, requiring more profits or less growth over the recovery time period. If the deviation caused surplus to grow faster than risk, then the decision of whether to regain the prior lower balance is still difficult but not usually painful. This may open the door for growth in an area where profits are not as high as other business or where they are less reliable; or for an increase in dividends; or simply held to offset future unfavorable deviations.

Then there are the parameters that produce balance. The following is an example showing the combined ratio targets that produce the indicated risk/business and surplus growth pairs for a hypothetical property and casualty insurer. This insurer has high reserves, generating high investment income, without contribution from insurance margins. It can fund a balance at 6% business growth. Growth beyond 6% requires some contribution to profits from insurance through a combined ratio below 1.00.

Combined ratio on the Y-axis and Risk Growth and Surplus Growth percentages on the X-axis
Figure 3: Combined Ratio for different targets

In figure 3, the leftmost, unbalanced column represents past actual performance. An 8% insurance loss (1.08 combined ratio) led to a 3.6% surplus growth, while business grew by 6.3%. So, in this case the challenge for planners striving for balance is to choose a combination of reining in growth and decreasing or eliminating insurance losses that is achievable and acceptable.

Surplus grows faster than business

Most often, an insurer that chooses to grow surplus faster than business has experienced either a sudden large loss or a prolonged period of surplus growth that was slower than that of business. The latter happened to many insurers that had depended upon investment earnings, rather than insurance margins, as the earnings on their portfolios dropped and dropped as interest rates fell to historical lows. The insurer in question needs to decide how much faster surplus needs to grow, which might be stated in terms of how long to get back to the desired surplus to risk relationship.

Figure 4 shows how the combined ratio target changes if it is decided that surplus should grow at 1% faster than business. You could imagine how this could quickly become unobtainable if significantly higher differentials are set. The strategic CRO who brings this kind of illustration to a planning meeting may be able to spark a very lively discussion of the realistic choices related to risk and surplus growth.

Combined ratio on the Y-axis and Risk Growth and Surplus Growth percentages on the X-axis
Figure 4: Combined Ratio for different targets

Business grows faster than surplus

This situation arises when an after a period of building surplus, an insurer now feels that there are business opportunities justifying moving in the opposite direction. It is somewhat common that an insurer in “Build Surplus” mode will have adopted a very conservative business posture and overshot its target for adding to surplus.

The same sort of choices as in the above apply, but an additional issue arises. When this type of change in thinking occurs, it is often accompanied by a shift from a cautious business approach to an aggressive one. If the aggressive approach leads to expansion into an activity that tends to punish the inexperienced, the company may be quickly thrown back to a plan where surplus needs to grow faster than business. A strategic CRO needs to be very careful in this situation.

Regardless of whether the insurer is focused on growing surplus or business, the strategic CRO needs to be prepared to talk about the balance.


Head of Willis Re ERM Advisory

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