Subrogation Buyouts Bring Fast Capital While Allowing Focus On Core Issues

Subrogation is the principle that allows an insurer, after paying a claim to an insured under a policy, to recover from another legally liable party. While carrier adjusters may do the work of pursuing subrogation collections themselves, some outsource the process to any one of dozens of subrogation firms–a strategy that's growing more popular, according to service providers.

Sales of subrogation portfolios are the latest development in the subrogation services world. However, selling isn't an entirely new concept. Announcing its ability to tap into a $100 million credit facility for buyouts in March, Westport, Conn.-based Subrogation Partners is actually the second firm known to National Underwriter to offer to purchase subrogation portfolios.

Latitude Claims Services in Bloomfield, Mich., pioneered the purchasing concept in the late 1990s, and Bradley Schram, president of Latitude Financial Group, Inc., admitted that while the concept has gained steady acceptance, it didn't take off immediately.

Mr. Schram explained that Latitude Financial manages two companies–Latitude Claims Services, the purchasing arm, and Latitude Subrogation Services, an operating entity that does the processing work once the sister company makes a bid and acquires the claims. In addition to its work related to purchased portfolios, Latitude Subrogation provides services that aren't attached to buyouts–working files on a contingency basis in some cases, and in others, working as the full-service in-house subrogation departments for insurance companies.

"If we don't collect, we won't get paid, he said, referring to contingency work, "and when we've discovered a file opportunity, we will bid on it," he added, noting that the willingness to buy files sets his firm apart from subrogation services competitors.

With Latitude's work roughly divided between in-house and contingency work, he said the purchasing option, "which has been consistent," still lags behind those two areas. The financing idea "is still being understood and accepted as a concept," he explained.

The concept is sometimes difficult for a claims person–and not a numbers person–to grasp. "That's just not how they look at the business on a day-to-day basis," he said.

He also predicted that interest might pick up "in view of some substantial problems that we've seen with some insurers," related to uncontrolled growth and other issues. "Companies will recognize that there's a twofold need–to just reduce the amount of overhead and complexities of their businesses, as well as the benefit of having the present value of the funds."

It's that financial benefit that executives of Subrogation Partners stress in meetings with customers and even with National Underwriter. Sharing a presentation the firm recently gave at a conference of financial managers labeled "Plagiarize With Pride," Mr. Manion explained that in developing the theory of subrogation portfolio buyouts, the firm is "stealing the playbook from other financial products," including the market for credit card receivables.

When credit card users don't pay bills, after 90 to 120 days, banks that service them send them to third parties that try to collect, getting paid by the banks on a contingency basis. The third parties also will buy the portfolios, he said, noting that in 1990, sold assets in the credit card receivables market were about $200 million. By 2004, they soared to $50 billion, he said.

Participants in the credit card industry "saw they could continually get enhanced recoveries," which spurred them to take on more clients, he noted.

Mr. Manion further explained that in 1990, 80 percent of all credit card recoveries were managed in-house. Today, only 4 percent are, he said, drawing a parallel to the subrogation world where 94 percent of all recoveries were handled in-house in 2004. That's down from 96 percent in 2002, he noted, suggesting that the doubling of the outsourced piece within two years is evidence of an exponential growth trend.

At Latitude, Mr. Schram had his own evidence of the growth in the use of third-party subrogation services, noting that his firm, which had only four employees in 1999, now has a total of 30.

Increasingly, he said, "we're becoming a safety valve" for insurers, when claims staffs become temporarily inundated because of a catastrophic event, a retirement or pregnancy. In other instances, insurers cut back as they focus on core competencies of providing customer service, quick claims adjusting and good underwriting, he noted, explaining a growing demand for full-service outsourcing.

Paul Fershee, president of the capital group of Subrogation Partners, said that while insurers are very good at handling claims, subrogation recovery requires "a different mentality." Instead of making sure insureds are taken care of, suddenly, they're supposed to take care of themselves–"to be a plaintiff and adopt another mindset."

Subrogation has been described "as the ugly stepchild of the insurance industry," he said, explaining that it too often gets put aside as insurers focus on other issues.

Mr. Manion said visibility of the subrogation asset has diminished further as workloads have increased, with consolidation, efficiency initiatives and systems conversions all pushing subrogation opportunities into the file drawer. "Whether it's a carrier or self-insured, these assets just tend to get lost for various reasons."

While Mr. Manion estimates that there is a $12 billion market for subrogation purchases, extrapolating from his firm's client base and market shares (both insurers and self-insureds), he said he hasn't factored in the fact that recoveries will be enhanced when assets are sold to specialists who focus only on subrogation recoveries.

Still, at least one analyst is skeptical that subrogation market development will track the credit card market. "Salvage and subrogation are an important element of the claims process, and if you can make recoveries to offset your losses, it's a positive," said James Auden, senior director at Fitch Ratings in Chicago. "But in the whole scope of things, salvage and subrogation are pretty small elements," he added, referring to industry aggregate figures captured on Schedule P of insurer annual statements.

As of year-end 2003, $9.6 billion of salvage and subrogation recoveries were anticipated for all accident years combined, compared to over $400 billion in unpaid losses. "That's just over 2.0 percent," he said. (Comparable figures for 2004 accompany this article as an "NU Data Insight.")

"I don't know if you can build a market on that. If you look at the amount of credit card receivables out there, that number is a lot bigger," he said, adding, however, that while he hadn't heard of the concept prior to NU's query, "this could be a good niche business for somebody. If companies don't have expertise to collect on some of these things, that can add value and be mutually beneficial."

Scott Conant, president of Subrogation Partners, noted that 60 percent of the commercial subrogation market is in the self-insured arena–and executives from both subrogation firms say self-insureds are a growing part of their client bases. Risk managers are taking on more work with less staff, Mr. Manion said.

Mr. Schram said self-insureds are receptive to outsourcing and buyouts simply because pursuing subrogation isn't their core business, noting growing interest among municipalities, in particular. "In many ways, it's found money to them," he noted.

However, even for self-insureds, there's a visibility issue, Mr. Manion contended, noting a disconnect between CFOs and risk managers. "As a [non-insurer] CFO, I'd walk past the controller, past the accounting manager, past the treasury guy, past the tax guy," he said, noting that the risk manager was way down the hall. Not only don't risk managers get proper attention, but their absorption in processing issues doesn't line up with a CFO's focus on analytical issues.

Like Mr. Manion, Mr. Schram sees different thought processes at work, even at insurance carriers. "I think part of the reluctance has been the failure to recognize that there is considerable overhead associated with maintaining the files beyond the mere cost of the employee's salary. That typically gets recognized at a CFO level but isn't necessarily recognized at the claims or subrogation level," he said.

Mr. Manion expects buyouts to grow as carriers–mutuals, in particular–recognize needs for increased capital. "When they need capital, they can end up selling assets–buildings, for example." This is an alternative hidden asset to monetize, he said, citing surplus notes backed by subrogation recoverables as one of four types of purchase options on the drawing board at Subrogation Partners. Others are:

o The straight portfolio-transfer option (also available from Latitude).

o Sales of subrogation futures–recovery rights for claims that have not yet occurred on in-force business or business yet to be written.

o A policy option, or sale of subrogation rights for all policies written for a specific line of business.

By reviewing a carrier's history, Subrogation Partners might estimate there's $1 of subrogated claims created, on average, for each policy, Mr. Manion said, explaining the last structure. The firm could agree to pay the insurer $1 per policy upfront, and the insurer would transfer claims under the policies allowing the firm to pursue subrogation. He noted the attractiveness to CFOs who want to be able to better forecast earnings per share, replacing uncertainties about recoveries and costs of the recovery process with a steady stream of payments.

Describing the pricing of buyouts generally, Mr. Manion and Mr. Schram each said they review files for recovery potential, consider risks involved, time to collect and cost factors. Mr. Manion added that, in some cases, pricing structures allow sellers to "share in upside potential." In other words, if the subrogation firm recovers more than anticipated, buyer and seller may agree to split the balance.

Mr. Schram said that while pricing depends on the mix of files, Latitude might bid anywhere from one-third to one-half of what files might be worth. Mr. Manion offered that deals for his firm might range from $1 million to $50 or $60 million per portfolio, suggesting that the ability to tap $25 or $50 million of new capital could help insurers looking to enhance credit ratings or prevent rating agency downgrades.

"Maybe in a distressed situation, that could help," Fitch's Mr. Auden said. "For example, if they're struggling to meet their interest payment on their debt."

But "that's a trigger you could pull once," he added. "If the company's in trouble, there are probably other fundamental problems. A quicker recovery on subrogation probably wouldn't make that much difference."

Infographic: Table Format? Two Companies Side by Side

Flag: Profiles

Head: Two Firms Pursue Buyouts

Company: Latitude Claims Services, Bloomfield, Mich.

No. of Buyouts: Latitude purchases from more than 20 companies.

Philosophy: Executives at Latitude repeatedly stress a focus on building long-term relationships with carrier personnel as a strategy that allows outsourcing assignments to blossom from initially more limited engagements.

Jon Coscia, director of operations, notes that sensitivity to insurer claims personnel is an important part of relationship building. "We're all former insurance company managers, executives and claims handling specialists," he said. "We don't make waves. We blend quietly in the background," he said, noting that work is done onsite or remotely, depending on clients' requests.

Company: Subrogation Partners, Westport, Conn.

No. of Buyouts: Executives aren't disclosing the figure yet, but CFO Kevin Manion revealed that three clients signed on for purchase deals during the week of NU's interview.

Philosophy: Executives stress an ability to tap into a $100 million credit facility and highlight parallels to the financial markets that developed for credit card receivables, viaticals, student loans and mortgage obligations.

CFO Kevin Manion said, "Early adopters of the subrogation capital markets will be well rewarded, not only as industry leaders in subrogation results, but [they will also] achieve superior operational efficiency gains, expanded asset utilization and growth in marketshare–just as the banks have enjoyed."

#2 Infographic

Flag: Selling Points

Head: Why Is This A Good Idea?

Until now, they've been invisible assets, but dollars hidden in subrogation portfolios may be ripe of discovery, proponents say. They point to several factors:

o Insurers' need for cost efficiencies.

o Insurance industry consolidation, which involves integration of claims-handling departments.

o Insurers' need to increase capital and strengthen credit ratings.

o More education about benefits of third-party subrogation services and buyouts.

o Overworked risk management departments for self-insureds.

o Greater communication about finance between risk managers and chief financial officers.

o Desire to relieve staffing pressure, focus on core business of settling claims not engaging in plaintiff-style pursuits.

o Replace uncertain costs of future subrogation activities, financing alternatives with certain payments.

FOR NU DATA INSIGHT BY GROUP

Flag: Lifting the Fog

Head: (ON TABLE)

Caption:

The invisibility of the subrogation asset is particularly evident on financial statements filed with insurance regulators. In statutory filings, anticipated subrogation is not recorded as an asset at all. The only place it appears is on the various loss reserve schedules by line of business–Schedule P–and there it is combined with totals for anticipated salvage. In 2004, insurance groups reported just about $10 billion in anticipated recoveries for both subrogation and salvage, with percentages to reserves varying from zero to 17 percent. Twenty-five insurance groups ranked by anticipated subrogation totals are shown here. (Go to www.NationalUnderwriter.com/pandc/ and click on "NU Data Insights" under "This Week" for a list of 150 insurance groups.)

FOR NU DATA INSIGHT BY LINE

Flag: Market Potential

Head: (ON STORY)

The management team of Subrogation Partners sees a $12 billion purchase market buried in the subrogation portfolios of insurers and self-insureds. Although figures for 2004 show that only $10 billion was anticipated for both salvage and subrogation recoveries by insurers, according to Scott Conant, the president of Subrogation Partners, nearly 60 percent of the market potential lies with self-insureds. Anticipated salvage and subrogation totals by line of business for insurers only are shown here.