In a Bind
Article, Post Magazine – November 2009
Ben Hobby, of the RGL London office, asks whether technology can be used for the day-to-day management of binding authorities and, if not, what other tools are available to underwriters
Binding authorities have traditionally been used by underwriters as a way to gain access to markets they would not ordinarily have been able to tap into. And, as markets emerge, underwriters will continue to use binders as a vehicle to participate in economic growth.
Given this situation, binders are likely to increase in importance over the coming years and there are moves to boost the use of technology for the approval of documentation by underwriters. But can technology really be used for the day-to-day management of binders and, more to the point, can it be used to increase the reliance on the numbers that are reported by a coverholder?
Binders will always contain an element of risk that can never be fully removed as a proportion of the underwriter's portfolio has been delegated to a third party. Therefore, the underwriter is wholly dependent on the coverholder providing accurate premium and claims information.
Traditionally, coverholder audits have been used to verify the accuracy of the reported bordereaux. These have proved to be of significant value to underwriters in identifying any issues that may have arisen. It is interesting to note that, in several of the reported cases in recent years where there have been concerns regarding the accuracy of the bordereaux, these were identified by an audit.
From an accounting point of view, the tests that are performed during a coverholder audit can include the following: a review of calculation of premium ceded to underwriters; confirmation that all premium to date has been ceded to underwriters; and verification that, for all claims, premium has been received and paid in full.
From the underwriters' point of view, it would be advantageous if a review process could be developed that would address the above audit tests prior to a bordereaux being approved for payment. It would also be beneficial for such a test to be performed on a timely basis so that the approval process is not delayed.
These kinds of tests naturally lend themselves to the use of technology. If each test could be included in an approval process, then the benefits to the market would be immense. However, each binder will have unique factors, such that no one binder is like another.
Given that there are in excess of 5000 binders in the Lloyd's market, a separate test would need to be designed for each binder. Furthermore, the terms and conditions of each binder can change year-on-year, meaning that these tests would need to be reviewed and updated on an annual basis.
It is clearly not impossible to design and implement such a system — but the cost of designing, implementing and maintaining this for the Lloyd's market using current technology is likely to be prohibitive.
Does this mean, then, that underwriters are solely reliant on the traditional audit of their coverholders? The answer to this has to be no, as there are other tools available to underwriters that achieve the same objective.
Before any report setting out financial data relating to the binder can be fully relied upon, it is imperative to know how this report has been produced. This is becoming more relevant for underwriters given the increased use of automated systems in the production of bordereaux.
But how is this put into practice? The answer lies in ensuring that the principles and processes underpinning the preparation of premium and claims bordereaux are known and understood. This will allow underwriters to identify where there are any potential weaknesses in the reporting processes and request appropriate corrective actions of their coverholders.
However, this review should not only occur at the beginning of a new binder; businesses engage in continuous improvements of their own operating systems, which cause processes to change over time. In addition, staff changes can prompt procedures and controls to change, leading to potential issues arising if these are not promptly identified.
If such changes are not understood, it is possible that issues in the accuracy of the numbers contained in monthly bordereaux will also not be identified on a timely basis. This could lead to underwriters receiving incorrect amounts of premium from their coverholders. Just as significant could be the possibility that underwriters are paying incorrect values for claims.
Understanding business processes, however, only represents part of the information required. It is important to ensure that these operate on a continual basis. An increased amount of electronic reporting of bordereaux allows underwriters to analyse this information in spreadsheet or database form. Other, more complex, software analysis tools also exist that can be used to test the accuracy of the data that has been presented.
But what is to be gained from performing this continual review work? Fundamentally, it allows underwriters to identify, on a timely basis, any significant issues with the accuracy of the reported data. While coverholder audits will always be required to make sure that the bordereaux agree to underlying documents, the knowledge gained from the continuous review of bordereaux data will allow underwriters to assess the frequency of these audits. Furthermore, the agenda for any meetings with a coverholder can then become more focused and, hence, more productive. Long term, it is to be hoped that the cost of auditing to underwriters would reduce.
It is clear that a fully automated system for verifying the accuracy of bordereaux is a long way from being implemented. But a well-designed data and process review can result in a reduction in the risk of reporting errors for underwriters. It can also lead to a reduction in monitoring costs, as the level of required monitoring should reduce over time.
The benefit of this is improved relations between underwriters and their coverholders and, potentially, an increase in profit for all parties.
As appeared in Post Magazine, November 2009.