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InCo is a commercial insurance company. The company engages in three activities as follows:

1. Underwriting: This is the main activity of the company. It offers insurance policies to business of all sizes and types, which protect against most risks for these businesses (e.g., fire, theft, liability). It receives regular payments from clients in return for the insurance policies provided to them, and this revenue is known as premium income. The underwriting costs that InCo has include claims (i.e., when a client requests reimbursement for damage or loss under their policy) and operations (e.g., general administration, sales and marketing). The difference between the premium income and the underwriting costs is known as the underwriting profit. InCo sells the majority of its insurance policies through insurance brokers, who are independent sales agents offering a wide range of policies from many different insurance companies.

2. Investment: Insurance companies usually hold large sums of money aside to cover potential future claims from their clients. Rather than simply leaving the money alone, InCo invests the money in the markets to try to make further revenue. This revenue is known as investment income. The difference between the investment income and any associated costs (e.g., investment charges) is known as the investment profit.

3. Risk consulting: InCo offers a small consulting and advice service to large clients to help them reduce their overall business risk in return for a fee.

Over the last 3 years, InCo’s underwriting profit has been declining. Last year, InCo had a premium income of $700 million. Its claims cost represented 83% of premium income and its operations cost represented 20% of premium income. Therefore, InCo experienced an underwriting loss. Last year’s investment profit more than compensated for the underwriting loss. However, the investment profit also declined and is expected to decline further due to low interest rates and weak stock markets.

The CEO of InCo asks McKinsey to help him determine how InCo could improve its profits. In the first meeting, he informs you that he believes that little can be done to improve investment profit. The cost of underwriting operations seems to have increased over the last few years and claims cost has increased in line with premium income. He also states that the main idea of having a risk consulting business is not to make additional profits via earning fees, but to realise considerable indirect mutual benefits for InCo and its clients.

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    1. Assuming claims cost remained at 83% of premium income and operations cost remain unchanged in $US millions compared to last year, in order to make an underwriting profit of zero, InCo would have to increase premium income by approximately what percentage?

    A. 3%B. 12%C. 18%D. 20%

    2. Assuming the relationship between premium income and costs remains the same, which of the following events would have the most positive impact on InCo’s profits?

    A. A 1% increase in premium incomeB. A 1% decrease in operations costC. A 1% decrease in claims costD. A 1% decrease in administration cost

    Analysing InCo's "book" (i.e., the total of all existing insurance policies), your team first looks at how premium income is distributed over individual policies.

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    3. Assuming that Group A policies have an average claims cost per policy of $200, which of the following statements can be concluded from Exhibit 1?

    A. InCo makes an average underwriting loss on these 33% of policiesB. InCo makes an underwriting loss on ALL of these 33% of policiesC. InCo should increase premiums for these 33% of policiesD. InCo should stop offering these 33% of policies

    Discussing Exhibit 1 with the head of underwriting, you learn that she had considered cancelling Group A policies. However, in talking to the head of sales she found out that there are strong arguments against doing so. One reason is that large clients who hold several insurance policies with InCo might take all of their policies to a competitor if a small premium policy is cancelled. Also, brokers who generate a big portion of InCo’s premium income might move
    to competitors with all of their policies if they cannot place small premium policies with InCo.

    Since a large portion of InCo’s premium income is earned through brokers, the team decides to analyse the profitability of policies sold through each broker. Broker profitability is measured by the claims ratio, that is, the claims cost on the policies sold by the broker as a percentage of the premium income earned by the broker. Exhibit 2 shows the performance of three different classes of brokers (marked A, B, and C) on the InCo policies they sold over the last 5 years.

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    Exhibit 3 shows some data on the share of premium income contributed by each of the three classes of brokers (i.e., A, B, C), as well as the number of brokers in each class and the average claims ratio for each class of brokers

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    4. Based on the data presented in Exhibit 3, which of the following statements is a valid conclusion?

    A. The average premium income of Class B brokers is larger than the average premium income of Class C brokersB. The average premium income of Class A and Class C brokers is smaller than the average premium income of Class B brokersC. The average premium income of Class A and Class B brokers is larger than the average premium income of Class C brokersD. The average premium income of Class A brokers is larger than the average premium income of Class B brokers

    Talking to the head of broker relationships, you learn that InCo historically classified brokers according to premium growth expectations. He informs the team that personal relationships with brokers can change quickly and have serious consequences. For instance, an upset broker can quickly move his business to one of InCo’s competitors. While this hurts InCo less with a smaller broker, it can hurt InCo significantly with the larger brokers. In addition, InCo is already short on people who can maintain their current broker relationships and would not be able to deal with the additional work involved in maintaining these relationships.

    5. Which of the following statements, if true, would be the strongest argument for discontinuing business with underperforming brokers?

    A. The majority of InCo’s underperforming brokers do more business with other insurers than with InCoB. Small broker enterprises run by less than 5 people account for most of InCo’s underperforming brokersC. Most underperforming brokers provide predominantly small premium policiesD. There are too many underperforming brokers for InCo to manage with their current resources

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