Executive Summary
This paper examines the use of indexation in the review of portfolio trackers and documents methods to measure it. Currently, there is no universally accepted market standard for measuring indexation. As heightened attention has been placed on the performance of portfolio trackers, it is becoming increasingly important to accurately report and be able to compare indexation across facilities so that targeted action can be focused on areas that require it most. It can also form part of contractual arrangements between a portfolio tracking coverholder and underwriters, enhancing the need for calculations to be accurate and transparent. The following discussion suggests a framework for measuring indexation that could be adopted by underwriters and coverholders if thought appropriate.
What is indexation?
Portfolio trackers are supposed to ‘track’ or ‘index’ an entire portfolio of risks, sometimes across many classes of business. Indexation is a measure used to track how well capacity is being deployed across a portfolio. Indexation can also be used to detect anti-selection, i.e. where capacity is more likely to be deployed behind hard-to-place/lower performing risks as opposed to being deployed across all in scope risks. It is not relevant for coverholders operating other follow facilities in which the aim is something other than to track an identified portfolio or risks.
Indexation is typically reported as a percentage – premium or policy count in respect of bound business divided by that which is in-scope for the portfolio – where perfect indexation is 100% (see below). Other terms commonly used in relation to indexation include ‘utilisation’ and ‘adoption’. While these may sometimes refer to distinct metrics, they are frequently used interchangeably, highlighting the need for clarity, so all parties understand what is being measured and reported.
It may be the coverholder’s responsibility, if set out in the agreement, to gather all the relevant information and data to calculate indexation in an appropriate manner. The accuracy and completeness of this should be an area of audit or due diligence of the underwriter.
Why is it important for portfolio trackers?
Portfolio trackers should, in theory, balance the good with the bad as they should reflect the in-scope portfolio. If capacity is unfavourably deployed towards historically poor performing risks rather than evenly across the portfolio, then the loss ratio of the portfolio tracker may be impacted, affecting the long-term sustainability of the facility. Conversely, portfolio trackers should not tend to be selective toward the best-performing risks, as they aim to track the entirety of a portfolio that supports the needs of brokers to offer capacity to their clients.
Portfolio trackers succeed through diversification of risk, often by class of business and/or geography. The initial assessment of a portfolio tracker opportunity by carriers involves reviewing the composition of an existing portfolio and future development projections. Any large deviations from the anticipated portfolio mix can impact the success and therefore long-term sustainability of the facility. For example, a facility may have been presented as being 65% short tail, 35% long tail, so if indexation in long tail casualty lines is poor, then the carriers’ appetite may no longer be satisfied by the facility.
Furthermore, large deviations from the anticipated portfolio mix will result in inaccurate actuarial pricing: portfolio trackers typically apply a development pattern based on the projected business composition and derive an expected ultimate loss ratio accordingly. Significant deviation from the anticipated portfolio, i.e. indexation at significantly less than 100%, can lead to an inappropriate ‘loss pick’, reducing a carrier’s ability to accurately reserve.
Monitoring how well indexed a portfolio tracker is relies upon coverholders regularly reporting on indexation metrics, so that any areas of concern around low levels of indexation can be identified early, and a proactive approach can be taken to address the concern.
Methods of measuring indexation
As mentioned above, a standard formula for indexation is set out below: a variety of different metrics can be calculated by replacing the X in the formula (e.g. most likely to be premium or number of risks in the potential portfolio).
The fraction denominator within this formula (i.e. the bottom number of the fraction) is the ‘in-scope’ portfolio – getting this right is difficult and critical – and the top line is the portfolio that has been bound.
The process of measuring indexation can be broken down into three main elements: scoping methodology; reporting metrics; and reporting of missed opportunities.
Scoping methodology
Successful indexation measurement relies on the accurate and transparent assessment of in-scoping risks. Underwriters and coverholders have varying approaches as to what is considered in-scope for indexation. Illustrative examples of “outcome reasons” and categorisation for in/out of scope are given below.
| In scope (included within the denominator) | Out of scope (excluded from the denominator) |
|---|---|
| Not taken up due to broker choice | 100% single markets |
| Not offered due to late submission | Unapproved leaders/risk codes |
| Not offered due to delayed referral response | Policy periods exceed maximum for facility |
| Not offered due to limited aggregate capacity | Excluded territories/insureds/failed ESG |
| Client declinature – pricing | Suitable alternative option taken up |
| Client declinature – insurer continuity/loyalty | Broker lost the account at renewal |
| Client declinature – outstanding claims | Referral declined |
On the above table, where the parameters of the facility have restricted the placement, this should be deemed ‘out-of-scope’ as there is nothing the coverholder can do to place the business in the facility. ‘In scope’ reasons are those over which the coverholder has some degree of control or influence over the placement or otherwise of the business in the facility.
It may be that it is unclear as to whether a given item should be deemed in or out-of-scope for indexation purposes e.g. reduced lines/missed opportunities due to limited aggregate capacity. The scoping exercise is typically carried out jointly between the Lead Underwriter and coverholder, and the in-scoping criteria shared with the panel participants for transparency. Following this in-scoping exercise, the quality and range of reporting metrics then add quantifiable results that can be monitored.
The in-scoping process is most effective when it occurs both prior to the facility period and during, by class of business. An initial assessment of the in-scope portfolio is necessary for parties to consider its likely performance. Underwriters should conduct an ‘ex-post’ in-scoping at regular intervals once the true subject portfolio is known with certainty. This allows for unknowns, such as new or lost business or any uncertainty or inaccuracies in the in-scoping process, to be corrected prior to the calculation of the indexation. This is necessary to avoid corrupting indexation measures with irrelevant data.
Reporting metrics
Some coverholders measure indexation by combining multiple metrics to aid high-level tracking over time. However, it should be remembered that there is no single measure that can fully convey the indexation of a portfolio. True indexation requires assessment using a variety of different metrics, as the success of one metric does not necessarily result in good indexation throughout. Examples of metrics that can be used to measure indexation include the following:
- % Client Indexation – proportion of in–scope clients that bound at least one policy.
- % Policy Indexation – proportion of total in–scope policies (UMRs) that were bound.
- % Premium Indexation – proportion of in–scope premium that was bound. This should ideally be measured using GWP for the portfolio tracker’s participation.
- % Layer Indexation – proportion of in–scope layers that were bound. This is typically done on a per-programme basis and then averaged across a portfolio.
- % Signings – proportion of offered capacity that was signed (written vs. signed line).
- Average % of Order (a) – the average signed % line relative to the total order of the policy. Note: relevant for portfolio trackers that offer lines based on order size.
- Average Signed % line (b) – the average signed % line. Note: relevant for portfolio trackers that offer lines based on whole only.
- Average Limit utilization – the average $ limit deployed across a programme.
The final three metrics listed above monitor the capacity deployment and can be used to assess any areas where capacity is being unduly restricted by the line size or capacity limits (e.g. where the percentage line is restricting the $ use or vice versa).
Policy and premium indexation measures are the most typical measures in use today. The more granular and regular the reporting, the easier it is to identify trends to proactively manage any actions required to improve indexation.
Reporting of missed opportunities
The final element of indexation that may be reported on is in-scope opportunities that were ultimately not taken up. For example, if a portfolio achieves 98% indexation, reviewing the reasons for the remaining 2% through an ‘NTU’ (not taken up) assessment provides context as to why they were not taken up, so these can be addressed to improve indexation.
Although out-of-scope missed opportunities are not directly relevant to indexation monitoring, tracking metrics will increase transparency and identify areas where expanding the facility’s scope may address gaps, such as risks involving unapproved leaders or risk codes. Underwriters and coverholders could also assess the relative performance of the out-of-scope business.
Conclusion
Reporting indexation with multiple metrics by class of business and in total provides a comprehensive picture. Regular reporting allows underwriters to fully assess the performance of the capacity deployment. Coverholders should have the ability to gather all the necessary information and data to calculate indexation in an appropriate manner.
Appendix A illustrates an example indexation report for a specific month across various metrics. The first two columns demonstrate the difference between the initial in-scope EPI prediction for the month relative to the revised EPI following any adjustments to the in-scoping exercise. At a high level this comparison allows recalibration of the indexation figures against the revised EPI, while still reporting on the initial EPI for the month so that carriers are aware of any movements against original projections.
Appendix B then shows an alternative view where a single indexation metric is selected, with variability shown by month per class of business. This allows for visibility of any trends in indexation over time, highlighting any areas of concern in need of review.
Appendix C goes into greater depth around the challenges associated with calculating indexation.