Program Market Picks Up Speed With More Carriers Entering Niche Race

"Now, there are a significant number of insurance companies that want to enter, or are in the program business," according to Mr. Lang. "There's more supply in the market [and] it's going in the direction of the mid-1990s," he said, noting that the likely driver of increased capacity is the general insurance cycle, which peaked last year and sent many companies looking for new areas of business.

Carl Bach, who heads up the Program Manager Solutions Specialty practice of Guy Carpenter, believes there are now more than 50 insurance company participants in the program business segment. His firm recently published a survey that was sent to 55 insurance company markets to gauge current appetites for program business.

Twenty-three markets responded, he said, noting that the most surprising result of the survey was that these respondents together said they expected to add between 70 and 80 new programs in 2005.

"Being in the market daily on these things, we realize how difficult they are to place, and the time it takes to place them," he said. Estimating that a minimum of six months elapses between the time a carrier decides to pursue a program with a managing general agent and the date a first policy is issued, he said that launches are slower for multistate admitted programs in highly regulated lines, such as automobile, with a lot of filing issues.

Carriers responding to the Guy Carpenter survey also said that together they write gross premiums of $10 billion related to programs, and three-quarters of them believe the figure represents at least half the market–with 72 percent putting the market size somewhere between $20 billion and $40 billion.

As to what's driving the interest in adding programs, Mr. Bach observed that "many of the markets missed their top-line growth targets in 2004 and continued to miss [them] in the first quarter of 2005."

"It's our feeling that with the current conservative approach in the marketplace on programs…that this may be the time to write a program and increase the top-line as opposed to writing 1,000 individual policies within a niche."

Defining the conservative approach with reference to controls, monitoring and efforts to achieve stable rate levels, Mr. Bach joined a chorus of market experts who said carriers are proceeding with caution as they forge ahead in the program arena this time.

George Lagos, chief executive officer and president of Syndicated Services Company–an administrative services firm specializing in program business based in Manchester, N.H.–said: "I don't think the pendulum is swinging back as dramatically as it has in the past."

"Program business has been something that has been in vogue and out of vogue on a fairly regular basis," he said, noting that he's been in the business 25 years. He believes carriers are now paying attention to three criteria required to write the business successfully. They are looking for:

1 Bona fide unique products, including unique risk management approaches, pricing techniques and distribution mechanisms–basically, "anything that characterizes target insureds as out[side] of the middle market."

2 Discipline, evidenced by a proven track record through both hard and soft markets.

3 Mutuality of commitment and understanding about program parameters and profit objectives.

Essentially, "it's a combination of the programs themselves and the program administrators. One without the other isn't a winner," he said.

"I don't see people jumping into the program business with both feet and just taking on all the programs they can get their hands on," he added. "That's something that has happened in the past, and it has not proven to be a great long-term strategy."

That message and the same expression of the three criteria were repeated by just about every carrier executive and program expert interviewed by National Underwriter.

Berkley Sees Opportunity

William Berkley, chairman and CEO of W.R. Berkley Corp., is very clear that Berkley Underwriting Partners–an operating unit created to take advantage of program opportunities–won't take on much more than double the nine programs it has now.

"We're always looking to find a few good programs, but our capacity is probably 15-to-20 programs. We can't really manage, in our style, more than that," he said.

"Here it is our sixth year and we haven't yet gotten to $200 million of business," he added. "No matter what we do, we couldn't do more than $400- or $500 million."

Mr. Berkley explained that growth isn't more aggressive because the company is selective. "You really only want to choose places where there is not a pure commodity product–where underwriting skill is an important aspect of the process."

"If it doesn't take great underwriting skill, there's no benefit in having a [managing general underwriter]," he said, noting that current programs include liability for elevator repair and pest control services, propane and fuel oil dealers, and asbestos removal engineers.

Berkley has had situations where it's had to exit programs. "We made a mistake," Mr. Berkley said. "It wasn't that the underwriter was bad; it wasn't a disaster…. But these relationships require the right chemistry."

Beyond chemistry, Mr. Berkley highlighted what he said is a "critical element" of the partner-selection process. As an MGU, "you have to be willing to put your money where your mouth is–to be paid significantly based on underwriting results," he said. Only people who believe in their own expertise are willing to sign deals where they may not get the most upfront but can make the most over a long period, he explained.

Berkley Underwriting Partners pays commissions that cover the MGU expenses upfront, and the MGUs benefit longer term through profit-sharing arrangements–assuming there are underwriting profits.

Mr. Berkley said while his company buys reinsurance for programs, it also keeps a big piece of risk, contrasting models that got carriers in trouble in recent years. (In fact, according to statistics available from National Underwriter Insurance Data Services, Starnet Insurance Company and Gemini Insurance Company, the issuing carriers for Berkley Underwriting Partners, wrote $246.2 million in direct premiums and ceded $239.2 million to affiliates.)

Berkley Underwriter Partners started up about five years ago, seizing an opportunity when "the market started to get difficult," he said–"when results were starting to get not so good and reinsurance capacity was starting to diminish."

A number of carriers had "abused the process," he said. They had "effectively put their paper out, transferred the risk to reinsurers, and didn't care at all whether or not they did a superior job at underwriting," he said, referring to a "fronting model" that many experts associate with the demise of Legion Insurance Company, among others.

The result was "a deterioration of the process for some significant part of the business, and for part of the business you still had terrific people doing a great job. But it all got blended up and the whole area of the industry became tarnished," he said.

"The most important thing to understand is that the derivation of this whole business was underwriting expertise. What got the business in trouble was when it went from underwriting expertise to marketing expertise. That's when it got not particularly attractive and not very nice," he said.

Clarendon's Evolution In Progress

Clarendon has experienced the pains of a fronting model and is still in the process of transformation, executives of Clarendon and its parent–Hannover Re–acknowledge.

On July 1, Wilhelm Zeller, chairman of the executive board and CEO of Hannover, announced a decision to non-renew $800 million of Clarendon's $2.3 billion program book, asserting that Clarendon's operating model would be transformed from one that generates fronting fees to an "underwriting model." He described this as moving from "program business to specialty insurance."

At Clarendon, Mr. Lang clarified the message. Clarendon won't be writing commodity business going forward, he said, contrasting specialized programs where the MGA has a narrow focus on a certain customer group or product line, which Clarendon continues to write.

"The main message I want to convey is that Clarendon is in the program business, and that we are looking for new business, not only renewing existing business," Mr. Lang said.

At Hannover Re's Investors' Day conference on July 1, Mr. Zeller said that by 2007, gross premiums will be about $1.9 billion. Describing the types of specialized programs that Clarendon will write, he said they currently include auto insurance for Cuban drivers in Miami, fine arts business, public entity business with high retentions and mobile phone coverage.

"What insurer would volunteer to accept insurance for loss of a mobile phone," when a young person wanting to buy a new one may intentionally lose an old one, Mr. Zeller asked rhetorically–explaining that specialized know-how is needed to put bells and whistles in place to make such programs work.

Gone from Clarendon's portfolio will be an admitted homeowners program in Florida that started out as a specialty program for mobile homes but grew into a commodity program that had the agent competing with Allstate and State Farm.

The shift, Mr. Lang said, "is not so much a revolutionary act that took place on the first of July. It started about three years ago. It's more of a continuation of a process than a sudden change. It's an evolution," he said, echoing remarks made by Mr. Zeller.

Mr. Lang said, "The general agents we want to do business with should know their market segments well, should have risk selection and pricing capabilities, [and] should know their customer bases," adding that they should also have systems that are (or can be made) compatible to Clarendon's.

Mr. Lang indicated that Clarendon is very selective about submissions it takes through its due diligence process, and even more selective about the programs that it actually binds. A number of reasons can contribute to the failure to make it to due diligence, he said, highlighting the presence of pricing adequacy, the existence of a true specialty niche, experience in the class, systems sufficiency and ethical integrity as key requirements for approval.

A key part of the continuing transformation will be that Clarendon will retain more business than it has in the past, he said, noting that Mr. Zeller's description of moving from "fronting to underwriting" referred to this change.

General agents will still underwrite most Clarendon programs, Mr. Lang said–noting, however, that in-house underwriting is done at Hannover's other U.S. specialty insurance unit, Insurance Corporation of Hannover in Itasca, Ill.

As for retentions, he said, five years ago, Clarendon retained 10 percent or less, passing the remainder on to reinsurers. Now, retentions are one-third, or more. "And going forward, we will retain even more."

Historically, even before Hannover bought the company in 1999, Clarendon "was very much fee-income driven and very much guided by reinsurers," Mr. Lang said. The flaw in the model was something "we had to learn the hard way," he said.

"Even though reinsurers entered knowingly into programs and always were invited to do audits and to monitor the business themselves, when programs turned bad–as happens because insurance is a risk-taking business–reinsurers' payments slowed down," he said. He added that was the case even though the reinsurers were quite solvent and had good ratings.

Currently, Mr. Lang said there are roughly 40 active programs written in New York, and another 20 in Itasca, adding that new programs would probably number about five per year. Exited programs, he said, are "more in the single- than in the double-digits."

During the Investors' Day conference, Mr. Zeller said a final component of Clarendon's transformation involves proactively and professionally managing the runoff of 150 programs that are currently in runoff, along with those to be added to the count as the migration from commodity business continues.

ACE: A Long-Term Proposition

When Robert Groff, vice president of the Program Division of ACE Westchester Specialty Group, uses the word "evolution," he is referring to a recent change that has expanded opportunities for the Philadelphia-based insurer.

ACE and its predecessor organizations have been doing program business for over 30 years, he said. "We were probably one of the first companies involved in the program marketplace," he added, noting that throughout its recent history, ACE has used an MGA model to write programs.

About a year ago, however, the company introduced an ACE-administered programs model to complement its existing MGA model, he said. He explained that the company recognized there were a lot of program opportunities for which there wasn't an MGA involved–where, perhaps a wholesaler or retailer placed a special class of business but didn't want to perform the function of an MGA or an MGU. "We stepped in to fill that gap," he said.

"We've been able to stay in the market over the years as others have come and gone," he said. "And now we offer a great deal of operational flexibility–be it MGA, or working with wholesalers and retailers on an ACE-administered basis," also adding that ACE can do programs on both an admitted and non-admitted basis.

To Mr. Groff, "the program marketplace is a long-term proposition [and] ACE has been a long-term player [bringing] a consistent and disciplined approach to the business."

Describing ACE's consistent approach, he said the insurer looks for "underserved classes of business." For the MGA model, ACE also seeks MGAs with proven track records and expertise in those classes.

Mr. Groff said examples of underserved classes written under current programs include carnivals, child care, straight-track auto racing and sprinkler contractors.

He said ACE will entertain most classes other than workers' compensation (where resources lie outside the program area in ACE USA rather than ACE Westchester) or classes where past experience reveals some real challenges. Nursing home business would be an example of the latter, he said.

Unlike Mr. Berkley and Mr. Lang, who put program size requirements in the $10-to-$25 million range, Mr. Groff said that ACE doesn't have any specified size parameters. "We are risk takers in the programs," he added. "We don't, from a skin-in-the-game perspective, require that MGAs take 10 percent or 20 percent of the risk. That's not our model."

ACE's most recent program additions target the food-processing, wholesale distribution and light-manufacturing sectors through an alliance with Tampa, Fla.-based Brown & Brown.

As for exits, Mr. Groff said, there have been a few over the years, left for "strategic" reasons, as well as some that were profit-challenged. Describing a strategic exit, he said specialty residential was one example–an area that the company opportunistically entered when the homeowners market was very difficult but exited when enough players entered so that the market was no longer underserved.

Currently ACE writes 26 programs–eight of which are ACE-administered, Mr. Groff noted. Declining to reveal the premiums written in programs or targets, he said: "We continue to look for program opportunities, [and] if it makes sense to do one, we'll go after it. But we don't have any quota that we're trying to hit as far as number of programs we're trying to add. The profit dynamics have to work for us."

Caption for Race Car Art:

Whether the target market is as exciting as race cars or as mundane as elevator repair firms, program business is back in the fast lane with a significant number of carriers entering the race.

Flag: Definition Of Terms

Head: What Is Program Business?

Juergen Lang, chief program officer of Clarendon Insurance Group in New York, provided a general definition of the term "program business" for National Underwriter.

"It's narrowly-defined homogeneous primary insurance business, where the traditional insurance company functions like acquisition, underwriting, policy issuance,…administration [and] claims handling are often outsourced to specialized and professional MGAs," he said.

"That doesn't mean that all these functions have to be outsourced all the time, nor are they. It depends on the situation and the relationship," he added.

Flag: For Sale?

Head: What's Ahead For Clarendon?

Not all the recent news about the program business market has been positive.

When Wilhelm Zeller announced Hannover Re's intention to "transform Clarendon"–its U.S. $2.3 billion specialty program business platform–he admitted that "disposal was also considered."

"But if we had decided to dispose of Clarendon right now in the shape it is [in], this would have meant destroying value–and we want to maximize value," he said.

"We think it always make sense to own a…business as long as we can turn it into a profitable venture–and we are convinced that we can do that," he said.

"What got the business in trouble was when [the industry] went from underwriting expertise to marketing expertise. That's when it got not particularly attractive and not very nice."

William R. Berkley, CEO

W.R. Berkley Corp.

"The main message I want to convey is that Clarendon is in the program business, and that we are looking for new business, not only renewing the existing business."

Juergen Lang, Chief Program Officer

Clarendon

"We were probably one of the first companies involved…. The program marketplace is a long-term proposition."

Robert Groff, V.P.

ACE Westchester Specialty Programs