Program Business: A New Paradigm

Program Business: A New Paradigm

Program business has always been the odd man out of the insurance business: an ill-defined segment that markets outside of the United States have been slow to embrace, with a volatile history that drove many program insurers and general agents out of business.

Only recently has program business re-emerged with some companies making great strides by addressing the core issues that plagued the industry. The results of this transformation have not only shown that program business can still thrive, but also that the efficiency advantages program business provides point to a coming paradigm shift that will be felt across all insurance sectors.

In the late 1990s, program business insurance underwent a crisis when poor practices finally caught up with economic realities. Different companies had different problems, but they all boiled down to one thing: nonexistent standards in everything from legal matters, information technology, program administration and, most importantly, underwriting.

Both undisciplined general agents and program insurers abused the fronting model that dominated program business. Because both parties made their profits on fees, they were concerned only with the volume of business, giving scant attention to the quality of the programs they were writing.

As a result, the reinsurers were stuck footing the bill on programs that should have never been written, and their withdrawal from the market led to the collapse of several prominent insurers.

Industry observers were quick to claim that program business was proved unsustainable and that it would slowly die off. However, these critics confused fronting with program business. It was fronting that led to the collapse, not program business.

Two questions emerged from the chaos: What exactly is program business? How must program business be conducted to capitalize on its strengths?

Even today there are many different definitions of program business. These usually mention homogenous lines of business, but agree on little else. The key element that is missing from these definitions is the outsourcing of functions closer to the policyholder.

While some point to the use of general agents as a risky element of program business, it remains an essential component and is arguably program businesss greatest strength. Because of outsourcing, program business is an incredibly efficient model. Rather than maintaining extensive back-office facilities to produce and process the business, in program business the personnel needs are reduced and processing expenses are capped based on the arrangement with the general agent.

In addition, many traditional insurers have multiple legacy systems that cause data integrity issues. With the outsourced model, a general agents system creates a “one and done” entry point, streamlining operations. Some program insurers can write significant volumes of business with only 5 percent of the staff than that a traditional insurer requires.

Moreover, the reason program business focuses on homogenous lines of business is that the general agents leverage their expertise to write very efficient, profitable programs. You cant have one without the other and get the same value.

So homogenous lines of business and outsourcing functions that are closer to the policy holder are the two critical aspects of program business.

That leaves the question of how to make it work. After all, many program insurers operated on these two principles in the 1980s and 1990s and still failed.

As explained earlier, strong underwriting standards that both insurers and general agents adhere to are the key ingredient to making program business successful.

Underwriting was not really a concern when program business was primarily fronted. In the new model of program business, profit is made on the program itself, not the fee, so underwriting cannot be ignored.

Program insurers are retaining an increased amount of risk and must enact strict underwriting due diligence on all programs to be successful. While insurers will still follow the fronting model in some cases, on a majority of programs written today they retain a significant amount of risk, sometimes approaching 75-to-80 percent. This was unheard of under the old model.

This isnt always welcome news for the general agent, since there is effort and expense involved in adhering to these underwriting standards. However, professional general agents absolutely understand their role in program business and the need for this approach. Strong underwriting is the only way to ensure profitable programs that meet the needs of general agents, insurers and reinsurers, as well as to create long-term, stable relationships.

When underwriting controls are matched with the efficiency of the outsourced program business model, the industry cant ignore the results. When conducted the right way, program business has built-in advantages that allow it to outperform the traditional model by a significant margin. As all parties gain experience in the new model of program business, and additional technology tools that ease operations are developed, that performance gap is almost sure to increase.

The implication for the industry is that there will be a paradigm shift from the bloated, traditional companies that dominate the industry today to a leaner, meaner modellike a military shifting from a massive army built to slog out huge battles during the Cold War to an elite strike force armed with the weapons, tools, and intelligence to act quickly and seize opportunities.

Does this mean that well see the program market increase in size? Probably not, but program businesss market share will steadily increase. Already were seeing new entrants to the market, and many traditional insurers are also switching to this less-expensive value chain.

However, for the large, traditional firms to capitalize on the advantages of program business is a tall order. Switching from a company that relies on its massive infrastructure to one for which infrastructure barely exists is incredibly difficult, both operationally and culturallyespecially if done as an experiment or a sideline to their core business.

Program business has proved to be a very successful model when the right approach is used. Those firms willing to embrace the new model and execute with discipline will reap the rewards.

Detlef Steiner is president and chief executive officer of New York-based Clarendon Insurance Group.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, January 30, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.