Successful dedicated insurance programs depend on many factors, not the least of which is excellent communication between the program’s agency and its new carrier partner. 

When the agency and the carrier are on the same page in assessing a program’s potential, there is less room for misunderstandings or missteps when that program becomes reality.  Thus, the growing rapport that develops between the agency and the carrier is a valuable byproduct of the admittedly arduous program submission, carrier review and negotiation process.

Part one and part two of this five-part series reviewed in detail the assembly of the program submission by an agency, identification of a carrier partner and the due diligence phase by the carrier. 

In part three of this series, we will review the finalization of the due diligence process—the financial modeling upon which a final “go” decision will be based and the factors that go into the negotiation of agency compensation.

Finalizing due diligence

After the carrier reviews the program submission, conducts due diligence and completes “home and away” visits with the agency, both parties will have a good idea if there are solid grounds for formalizing the program and introducing it to the market place.

We recommend that the agency and the carrier execute in writing a non-binding program proposal. While a period of exclusivity is usually not made explicit in such a document, there should be an understanding that a reasonable time will be allowed for finalizing the program and each is committed to proceed.

This proposal should address any open issues or execution steps that need to be documented. It is appropriate for the agency to ask the carrier to summarize its due diligence by functions and may include items like reinsurance support, forms reviews, filing requirements, pricing initiatives, claim authority levels and handling, anticipated coverage and limits, possible modes of compensation, technology tools and the data interface with the carrier.

In a way, this is now the agencies turn at due diligence. The agency should make sure that the carrier is completely identifying all elements needed to bring the program to market and that it has the capability to do so successfully.   

This non-binding proposal is an important stage of the due diligence process.  In practical terms, this begins the transition from “what we (the agency) have been doing” to “how we will be handling these areas (the program with the carrier partner) in the future.”

Financial modeling and department review

 With a conceptual proposal signed and accepted, the carrier should have conducted a financial modeling of the proposed program. This analysis will include the projected expense structure, the premium projections by lines of business and states, and the projected loss ratio. While the carrier will examine the historical loss pick, it is equally, if not more, important to derive a projected loss pick. 

The projected loss pick will take into account such factors as overall insurance industry market conditions, competition within the program category, more recent loss trends and specific activities and risks of the industry or service group being insured, and selection of risk criteria which may be prospectively different than in the past.

At the end of this modeling, the agency and carrier will have a clear expectation (projection) for the program’s combined ratio (revenue in relation to expenses and loss pick).  This calculation both serves as a benchmark for the program, should it go forward, and the starting point for the next stages of getting a program to market, which are compensation and final negotiation phases.

Components of compensation

The agency’s program submission will normally include a detailed compensation request.

Compensation plans for most programs will have a base commission, in addition to variable and/or incentive components.  The base commission will be comparable to conventional premium-based retail commissions and is usually the easiest part of the compensation to determine. This should be viewed as the marketing and acquisition costs.

Subject to negotiation, the agency can be compensated for insurance services that it provides. This may include items such as underwriting pricing, policy issuance, premium audit, claims coordination or administration and loss control services.  Generally, we believe that agencies shouldn’t “get ahead of themselves” and take on responsibilities for which they don’t have the necessary experience or infrastructure. Extra duties, and the accompanying compensation, can certainly expand revenue and margins.

However, these decisions should be based on which party—agency or carrier—can best fulfill a given duty. Typically, the more unique programs and more experienced agencies have invested significant technology and people resources to be able to take on some of these services.

The agency may negotiate incentive compensation. This incentive compensation will typically be based on (1) the size of the program and its growth in premiums; and (2) meeting combined ratio objectives.

Payouts may be calculated multiple times for a specific period following a given policy year.  Regardless, compensation must be “tempered” at this early stage to make sure that the program develops critical mass and builds up a reasonable loss fund that can support a severe loss incident. For this reason, it may be best to start incentive compensation plans in year two of the program. If necessary, a one-year or first year rollover incentive can help bridge the gap.

The goals in negotiating compensation are to establish a reasonable loss fund, while making sure that each party, agency and carrier, perceives that they are entering into a win-win, profitable relationship.  Agencies may also take an equity stake in their program, in lieu of incentive compensation achieved in part by a captive or some capital at risk variable compensation as it is earned.  Variable compensation is outside the scope of this article, although, clearly, during the Strength, Weaknesses, Opportunities and Threats, (SWOT) analysis, the carrier will be able to analyze the agency’s appetite for and ability to handle risk.

The final negotiations should make clear issues of trademarks, advertising and branding and related intellectual property, as well as define the conditions under which the agreement may be terminated.

On our way

A distinct and profitable book of business has been formalized into a program, a carrier partner found, due diligence conducted on both sides, a combined ratio projected, base and variable compensation negotiated and underwriting guidelines and authority are granted.

It is now time to begin fitting together all of the functional pieces of the puzzle to build the program. This phase is the program implementation process, which has its own set of challenges and important areas that must be addressed. Program Implementation will be discussed in the next article of this series. Topics to be covered will include regulatory filings and approvals, development of policy language and contracts, technology infrastructure and marketing, as well as taking a “last look” at the current market for the insurance line.

Conducting each step in the submission process carefully and thoroughly, in a spirit of frankness and cooperation, helps ensure that the new program finds acceptance in the market place, while meeting defined objectives for premium growth and return on investment.

Archie McIntyre is senior vice president of business development for Meadowbrook Insurance Group Inc. He can be reached at [email protected] or (248) 204-8518.