Why does your underwriter want to see your financial statements when considering your account? Today’s insurance underwriters face a “turbulent, highly competitive market,” according to accounting firm PriceWaterhouseCoopers (PWC). The highest performing insurers use “data-driven risk measurements and underwriting to out-select [their] rivals,” according to PWC. Your financials are a critical factor in those measurements.
In a Difficult Commercial Insurance Market, Financial Statements are a Benchmark
According to McKinsey & Company, “Underwriting excellence remains paramount to company performance.” Today’s insurers increasingly rely on data to make decisions. An organization’s financial bench strength is a critical factor in any underwriting decision on your commercial account. Insurers aim to insure the businesses that will have the fewest losses.
Underwriters must account for unfavorable conditions such as escalating “social inflation verdicts,” according to McKinsey. These high verdicts have affected commercial auto, liability and, increasingly, directors & officers insurance. To counter these verdicts, carriers have tightened underwriting standards and increasingly focused on loss prevention measures within the insured’s control. These include maintenance of fire sprinkler systems, fleet management, premises security and more. Underwriting also focus more attention on the organization’s financial performance.
Why Underwriters Evaluate Your Financial Statements
Listed below are some top reasons underwriters will ask for financial statements before writing your risk.
- Does your organization have other undisclosed ratable exposures? By evaluating your financials, underwriters may find differences between what your application presents and your actual financial picture. For example, you may have income on your profit and loss statement or expenses on the revenue side that alert the underwriter to loss exposures not explained on your application. You may have a manufacturing exposure that the underwriter doesn’t fully understand. At the end of the day, underwriters want to “… make sure that the premium being charged for the risk is a fair premium and appropriate for the loss potential the organization presents,” according to Richard Faber, President of Underwriter’s Resource, a training organization for advanced underwriting practices based in Arizona.
- Can the organization afford proper risk controls? Safety programs, maintenance of boiler and machinery, fire systems like Ansul systems – all require costly implementation and upkeep. In many organizations, if financials slip, safety may be the first item on the budget chopping block. Underwriters want to ensure your organization has the financial strength to implement and manage your safety programs.
- Can the organization afford to pay third-party deductibles and self-insured retentions? As the insurance market continues to harden, some organizations are embracing more risk. This means they seek alternative financing methods to reduce premiums while improving their loss control measures to cut losses. To do this, organizations often take self-insured retentions and higher deductibles. If you take a $10,000 third-party deductible on your commercial general liability policy, for example, the insurer will handle the claim and bill you for the deductible. Insurers want to know that you have the assets to reimburse them after a claim payout.
- Your financial strength speaks volumes about how you manage your company. “The most important reason to evaluate financial strength is what financial strength tells us about the client, “according to Faber. “There is a very strong correlation between the quality of the risk and the quality of their financial strength. Financial strength equals good management. Over the course of my underwriting career, I’ve found probably at least a 75% positive correlation between financial strength and good management.”
Which Financials Will Your Insurer Evaluate?
Insurers want to evaluate your key financial and management components, including those listed below.
- Income statements, including revenues, expenses and expense ratios
- Balance sheets, often with a focus on cash on hand, especially if you carry retentions or deductibles
- Cash flow statements
- Your company’s corporate history and structure
- A description of your company’s management team and their backgrounds
- Your disclosure practices when underwriting directors & officers coverage
- The insurer also may request audited financial statements
The ability of the underwriter to develop a clear view of your operation by evaluating your financial statements is imperative to the carrier’s accepting your risk. If your statements reveal inconsistencies, you’ll want to explain those before you send the reports. Taken in isolation, financial ratios – one quick way some underwriters evaluate risks – can be misleading. Especially for small-to-medium sized businesses like sole proprietorships or family-owned businesses, you may find little benefit to maximizing value. Owners taking salaries can skew financial ratios. Less experienced underwriters may not understand that.
Financial statements are more critical to underwriting today than ever before. For an overview of some key financial ratios that underwriters may evaluate, click this link.
Given the recent civil unrest in addition to COVID-19 concerns, underwriters increasingly rely on financial strength to benchmark your company. Our underwriting partners work hard to place commercial real estate risks in an increasingly difficult underwriting environment. If we can help you, reach out to us here.