This article was derived from Mr. Thompson's presentation atthe Fifth Annual Target Markets Program Administrators Summit,which was held in October in Tempe, Ariz.)

WORDS mean things–especially when it comes to contracts. That'swhy it's essential that program administrators give more thancursory attention to their contracts with insurance companies.Depending on how a contract is worded, it can pave the way for amutual profitable experience, or it can leave the programadministrator more or less at the mercy of the carrier.

Contracts between carriers and program administrators contain ahost of conditions and terms. In this article, I'll discuss anumber of them and provide suggestions for negotiating a contractthat will be an asset to your program.

Suspension: Watch out for provisionsunder which the carrier could suspend your underwriting authority.“Suspension” seems less terrifying than “termination”; it soundsonly temporary. But suspension can give a carrier a “below theradar” way to put you out of business. Try to limit its applicationto the greatest degree possible.

Termination: A carrier typically wantsthe flexibility to terminate the contract with little or no notice.Among the grounds for termination it may wish to include are thefollowing:

• Any violation of the carrier's guidelines.
• A combined ratio exceeding 100% in any underwriting year.
• An unapproved change in the ownership or control of a programadministrator's business.
• The carrier's loss of reinsurance.
• The cancellation, suspension or declination of the programadministrator's license in any state.
• Any change in laws or regulation that affects the carrier'sexposures.

A program administrator, on the other hand, should ask thecarrier to provide as much notice as possible in case oftermination, suspension of underwriting authority, change inunderwriting guidelines, or change in premium rates or coverage. Inregard to grounds for termination, a prudent program administratorshould negotiate for:

• A specified time period in which the program administrator can“cure” any errors or license cancellations.
• A provision stating that the cancellation of a license in onestate will not affect the program administrator's ability to dobusiness in others.
• A reasonable definition of what would constitute a change ofcontrol of a program administrator's operations. It's also wise toinclude a requirement that the carrier's acceptance of a change inthe program administrator's ownership or key officers “shall not beunreasonably withheld.”
• A requirement that the carrier exclude any catastrophe losseswhen calculating a combined ratio for purposes of determining if aprogram has failed to meet a target.
• In regard to the loss of reinsurance, a requirement that thecarrier give the program administrator advance notice and make agood-faith effort to replace it.
• A requirement that any change in a law or regulation that acarrier invokes to terminate a contract have a major, materialimpact on the carrier's exposures.

Exclusivity: Many programadministrators want exclusive relationships with carriers, but I'mnot sure that's desirable. Remember that most carriers are notgoing to give you a one way exclusive: they will insist on it beingmutual. Also, an exclusive is of little consequence unless there isat least a six months notice of withdrawal. What if the carrierloses its Best's rating? For a year, you may have to continue usinga carrier that has a “B”rating or worse. What if your carriersignificantly changes its underwriting guidelines? Or maybe it hasa rogue actuary who decides that your program's rates need todouble? You start to lose a lot of business. If you've given thecompany an exclusive, you're stuck for either the exclusive noticeperiod or for the life of the contract.

We once had an exclusive with Frontier Insurance Co. thatrequired us to give the carrier a year's notice to move theprogram. As we all know, Frontier filed for bankruptcy. Thank God,we also had a provision in the contract waiving the required noticeperiod if the carrier's Best's rating was downgraded. Because ofit, we were able to move the program before the situation becamecritical.

You can address some of these issues with contract conditions,but will carriers agree to them? In today's market, they oftenwon't.

An exclusive is not always so great for an insurer, either. Itcan saddle the carrier with a program administrator who's notgetting the job done–but is not performing so badly that thecarrier has grounds to terminate the contract on short notice. So Ithink a mutual exclusive with a lengthy notice requirement hasdrawbacks for both parties.

I prefer a “de facto” to a “de jure” exclusive. We simply agreewith the carrier that we will both act as if we have a mutuallyexclusive as long as both sides are basically satisfied with therelationship. I've found that when a carrier doesn't honor ahandshake agreement to give us an exclusive, we've been able todepart and retain the vast majority of the business. (I make surecontractually that we own the program's records andexpirations.)

Also, contracts aside, it's increasingly important these days tounderwrite your carrier partners. No contract is tight enough toprotect you from somebody who is difficult or unethical.

Insurer-specific trust accounts:Program administrators should, of course, separate their operatingfunds from those held in trust for their carriers. But insurersincreasingly want program administrators to create separate trustaccount for their business. That's not a problem if all yourbusiness is with one carrier; otherwise, it's a real headache.Certain states require separate trust accounts, but many permitprogram administrators to deposit collected premiums (net ofcommissions) for all carriers in single trust account. A programadministrator operating several programs constantly receives checksfrom retail agents, which contain premium payments for multiplecompanies. It's certainly a lot easier to deposit these checks intoone trust account than break them into payments for each carrier asthe checks come in.

Rather than create a separate trust fund for a carrier, a middleground is to create a joint account

Then, on a given date, you can transfer into it the carrier'saccumulated premiums from the single trust account, and it cansweep them out. The parties can work out the terms of the jointaccount, including when the program administrator would be requiredto move funds into it.

Ownership of claims data: A carriermay want a contract provision granting it the exclusive ownershipof the program's claims data, and requiring the programadministrator to ask for the carrier's permission before using it.The usual intent of such a provision is to bar the programadministrator from using the data to get another carrier. I'm not alawyer, but I question whether this provision is enforceable. As aprogram administrator, I need this information to conduct mybusiness. But rather than challenge such a provision in court aftera carrier invokes it, a better idea is to try to negotiate theprovision out of the contract at the outset. For instance, you cansuggest joint ownership of the data, or a provision requiring youto notify the carrier if you show the data to other parties.

Run-off provisions: In the event thata carrier stops writing new business and the program goes intorun-off, who services the business? Some contracts give thatauthority to the carrier. What if they do a terrible job ofprocessing endorsements for policies in run-off? The programadministrator's relationship with its retail agents and theirinsureds could be irreversibly damaged. I've also seen provisionsrequiring program administrators to return any unearned commissionsat the termination date of the contract. That fits into the “you'vegot to be kidding me” category.

We want the contract to give us the authority to run off thebusiness, as long as we adequately perform our duties. As part ofthat, we want it made clear that we have endorsement authority.I've seen contracts that require a program administrator to get thecarrier's approval for every endorsement issued during a run-off.But when your program is in the process of being closed down, youoften don't get much cooperation from the insurer, and therequirement becomes a nightmare.

It came from left field: I've seenbizarre contract provisions. Here are a few of them to avoid:

• You die, you lose: A provision giving the insurer the right toterminate the contract immediately in the event of the death of theprogram administrator's CEO. So if I have the bad manners to kickthe bucket, my estate loses everything I've worked for.
• “Cassandra” clauses: I once saw a contract provision requiringme to notify the company 30 days before the carrier is cited by anyregulatory authority or we would be responsible for any finesresulting from the violation.
• Responsibility for reinsurance uncollectibles: A company maytry to make a program administrator 100% responsible for anyuncollectible reinsurance, even if any negligence on the part ofthe program administrator was only contributory.
• Lopsided hold-harmless agreements: Some hold-harmlessagreements require a program administrator to indemnify a companyfor its negligence as well as the program administrator's. Holdharmless agreements should be equal. In so many words, they shouldsay, “I'm responsible for what I mess up; you're responsible forwhat you mess up.”
• Audit guarantees: If you can't collect on a premium audit, youshould always have the right to return it to the company within aspecified time (45 days is typical) which will take you off thehook on the audit premium although, naturally, you will lose yourcommission on the transaction. But I've seen contracts requiringprogram administrators to guarantee collection.

Responsibility for retail agents: Acontract may attempt to make a program administrator responsiblefor any willful or gross misconduct on the part of a retail agentthat adversely affects the carrier. You could have your contractterminated because of something a rogue agent did. That's tough tolive with.

Accounts-current terms: The number ofdays in which you have to pay your accounts current usually rangesfrom 30 to 60 days. We try hard to negotiate 60 days, given thatmost of our producers pay us on an account current basis, asopposed to cash with application.

Another issue is whether you pay accounts current by yourstatement or by the company's. One advantage of paying by thecompany's statement is that, if they are behind in coding, you mayenjoy a few extra days of float. A disadvantage is that you have toreconcile to their statement, instead of having them reconcile toyours, so you have extra accounting work.

Compensation: When negotiatingcommission, program administrators also should negotiate who isgoing to be responsible for such things as inspections, audits,MVRs and credit reports. These things can become major expenses. Itis also important to agree upon which party keeps the fees and anda range of how much is going to be charged. It's best to nail downthese issues in advance, so there will be no surprises on eitherside. Sometimes negotiating compensation can seem like rug buyingin a Middle-Eastern market. You may start a little high, thecompany may start a little low, and you end up meeting somewhere inthe middle. My preference is to argue for a reasonable number basedon the services rendered. While the standard program administratorcommission is 20%, this can vary greatly according to the line(s)of coverage, premium size and the overall profitability of theprogram.

Managing your attorney: When you workwith contracts, you need an attorney. Make sure you manage what theattorney does. It may sound cynical, but you have to remember thatattorneys get paid for being inefficient. The longer they take, themore they can bill you. So you have to make sure your attorneystays focused on what is important to you. Avoid having yourattorney negotiate directly with the insurer. A lot of people say,“Well, I'll just let the attorney negotiate the contract for me.”That can be a big mistake. I've seen attorneys drive the other sidecrazy over an issue that, at the end of the day, I was sure was ofminuscule importance. Certainly, you want to talk to your attorneyand get his or her feedback as negotiations progress, but the onlytime I let my attorney talk directly to the other party is whenthere's some detailed language that needs to be worked out. Thensometimes their attorney and your attorney can get together andexpedite things.

The most troubling words you can hear from your attorney are,“We need to research that.” Usually, that means, “We just hired alaw school grad who doesn't have enough to do. We're going to havehim do about 40 hours of research on some obscure issue in yourcontract, and you're going to get a big bill for it.” I tell myattorneys, “If you're going to research something, I want to knowwhat it is, and how much it's going to cost. Then I'll decidewhether I want the research.”

Finally, never, never have an attorney write a contract fromscratch. That's a recipe for disaster. I've heard of attorneys whowrite 200-page contracts from scratch that both parties wind uphating. So find a contract, any contract, and make the attorney useit as a starting point.

Negotiating a good contract is one of the keys to a program'slong term success. It may seem unimportant when you are starting arelationship, but it can save your life when you are endingone.

Greg Thompson is president of Thomco Insurance, which he and hisfather founded in 1979. The company operates more than a dozenprograms. Prior to founding Thomco, Mr. Thompson served on thefaculty of the European Institute of Business Administration inFontainebleau, France, and later joined Marsh and McClennan in NewYork. Mr. Thompson graduated cum laude with a liberal arts degreefrom Washington and Lee University and earned an MBA at theUniversity of Virginia's Darden School. Readers can contact him [email protected].