How to launch new programs in a changing market

Program business constitutes one of the most innovative segments of the insurance industry. Particularly for businesses that have difficulty obtaining coverage, program administrators often are able to draw on their expertise in a niche to develop highly customized solutions for it that include tailored policy forms and loss-control services.

Lately, however, program administrators have not found it easy to develop new programs for needs and opportunities they perceive in the market. While softening market conditions have renewed some insurers' interest in programs, they are requiring program administrators to make a strong case before agreeing to put their paper behind a new venture.

Greg Thompson, CPCU, president of Thomco, has pitched a lot of programs to carriers over the years. Recently, we talked with Thompson, who is in line to become president of the Target Markets Program Administrators Association in 2007, about what it takes to get a program insurer to say yes. Following is an edited transcript of our conversation.

AA&B: How long have you been in program business, and how did you get into this field?

Greg Thompson: When we first started Thomco in 1979, we really didn't imagine ourselves being in program business. Our original idea was to be an E&S wholesaler and write commercial lines of business on specialty or difficult to place exposures–think artisan contractors and so forth.

We found ourselves facing a lot of well-established competition, however, so we decided we needed a different business model and started developing programs in the 1980s. We had ones for offshore oil field contractors and logging contractors, among other risks. We made mistakes, learned from them, and finally got it right in the late 1980s, when we came out with a day-care center program, insured through Reliance, that launched us nationally.

AA&B: What did you find attractive about the program-business model, as opposed to working as an E&S wholesaler or other type of intermediary?

GT: Well, right off the bat, we noticed that for the day-care center program, our hit ratio on new and renewal business was much higher. We found that if you develop expertise in a certain niche, word gets around that you have a good program, good coverages and reasonable rates; that you understand the business; and that you can show producers how to sell the program against their competition.

AA&B: How many programs do you have?

GT: We have 12 national programs and three more that will be coming online next year.

AA&B: How receptive are insurers to new programs these days?

GT: As a general rule, it's difficult to get a new program off the ground, especially after the latest hard market. There was a lot of criticism of program insurers that had not done their due diligence. As a result, many programs turned out badly, and a prejudice against new ones developed.

AA&B: Has this changed as markets have softened?

GT: There is some softening in the market, but I don't think that's the main factor behind any resurgence in program business. My sense is that most programs coming online either have a track record–maybe someone has moved a program from company A to company B, has been able to negotiate more aggressive terms and therefore is writing more business–or that a program manager with a successful program has decided to expand it into a related field. That's a safer bet for a carrier than something that's brand new and different.

AA&B: When you attempt to create a new program, what sort of preliminary research do you need to conduct, just to see if the idea is feasible?

GT: A lot of research needs to be done, and it's extremely time-consuming. Frequently a retail producer brings us an idea for a program, although we also will choose an opportunity on our own and research it. In either case, you have to first understand the targeted industry exclusive of its insurance aspects. What are the business problems and opportunities? If you don't thoroughly understand the business, you'll never really understand its insurance needs, the aspects of its exposures that might make it unattractive to traditional insurance products, etc.

AA&B: How do you decide which industries to target?

GT: There are two things I look for. One, I like an industry that's growing, because the insurance market usually is slow to recognize an evolving industry and is always nervous about it. Even if we'd face competition in the industry, we'd be fighting over a growing pie rather than a shrinking one.

Second, I look for industries that are having difficulty obtaining insurance. If insurers are aggressively competing for business in the niche and already offering a lot of attractive options, our feeling is, “Why do they need us?” But if a market is truly under-served, and insurers feel they can't make money in it, we may investigate whether that prejudice can be overcome, perhaps by focusing on a segment of that market that will produce a good loss ratio.

AA&B: Where do you find the data that tells you whether a market is growing?

GT: You check with associations for that industry. You also spend a lot of time on the Internet. You “Google” yourself to death; but if you're patient and use the right words, you eventually find the data–or at least part of it–that you need to estimate the segment's growth.

AA&B: In terms of premium volume, how large does a new program have to be these days to be feasible?

GT: If you can't show a carrier that you're going to be at $10 million within two to three years, using acceptable underwriting guidelines, without writing a majority of the available business, I think the program is a non-starter.

AA&B: When you provide such growth projections, how do you convince an insurance company they are realistic?

GT: You estimate what's out there in terms of exposures units, and what their collective premiums would be. Then you state what you think your penetration of the market will be. Admittedly, a lot of this is subjective. You may say your product is strong enough to capture, say, 5%, 10% or 20% of the market. If you start getting into numbers like 30%, 40% or 50% of the market, you're going to have to convince the carrier that there is something unique about your product or that there's very little competition out there. Otherwise, they will be quite skeptical that you'll hit those numbers, because they're going to expect something more in the 5% to 20% range.

AA&B: What information do you have to put into a program proposal?

GT: I think the best way to answer your question is to give you a recent case study. A producer who had a $500,000 book of business in a certain niche approached us. It was all written essentially in two states. We were interested in taking the program nationwide. The dilemma was that the $500,000 book–although its loss record was very good–was not big enough to be actuarially significant to an insurer. So we used the Internet to find injury data in this particular industry–and we found more than we thought we could. Then we took the data to an actuary for analysis. Later, we brought in the insurance company's actuary as well. In the end, we were able to interest the carrier in the program and agreed upon rates expected to produce the desired loss ratio. The carrier increased the rates we originally proposed by 10%, but we feel we can live with that.

We're excited about this program, which is set to kick off by January, because it demonstrated to us that even if we are unable to start out with traditional premium and loss data for a program, it's possible for us to find a prudent insurance company that will do the deal. But in today's world, most insurance companies are actuarially oriented and will not take a chance on a program without some hard numbers they can put their arms around. That's where our actuary came in.

AA&B: What sort of information do you need to include about proposed forms and endorsements?

GT: In addition to covering the actuarial issue, a program proposal should demonstrate your mastery of the market. You should show the carrier what forms are out there, what forms you propose to use and why you think those forms will be attractive to prospects without excessively exposing the insurance company to loss.

AA&B: Are these standard ISO forms, or will they need to be customized?

GT: It could be either. In the program I just mentioned, we're using both manuscript forms and ISO forms. That's not unusual in specialty business.

AA&B: In that case, I take it the program provides more than one line of coverage.

GT: The program provides general liability, property, auto and inland marine insurance. The focus in on general liability, which businesses in this market have had an extremely hard time obtaining. The other lines were not hard to obtain; but the feeling was–from the carrier's perspective and ours–if you're willing to write the difficult part of the risk, why not require the other lines that are not a problem?

AA&B: What information about loss prevention and control should a proposal contain?

GT: We have an in-house risk management person, as do a number of program administrators. Really, to offer a program a carrier will feel comfortable with, the proposal should contain a detailed loss control plan.

AA&B: I assume you have the pen for all your programs, so what information do you need to include about underwriting guidelines?

GT: There is no way you can expect an insurance company to take you seriously unless you can explain why your underwriting guidelines will result in a superior selection of risk. You really have to be able to bring some expertise to the table. In the case of this program I just mentioned, the retail producer, interestingly, had tremendous expertise in this field. He had conducted a lot of claims research, as had others, but he also had contacted a lot of the manufacturers of the equipment used in this field and had become an expert on which models tended to cause claims and which seemed to have better safety records. We designed our underwriting guidelines around his research.

This retail producer will have an exclusive for a certain number of states. In other states he will be our underwriting consultant. That's unusual, but in program business, there aren't any rules–as long as you can underwrite profitably for the carrier. This agent's underwriting expertise was second to none, and so we wanted to leverage that.

AA&B: What information about marketing should be in a program proposal?

GT: An insurance carrier will always ask, “This may be a great program, you may underwrite it beautifully and give us a great loss ratio, but how do we know that you're going to be able to have enough penetration in the marketplace to hit your production numbers?” So you have to show them a marketing plan and the ability to penetrate the marketplace. If you're an established program administrator, it's easier to do because you can show a track record.

If you're going to offer a program on a wholesale basis, you have to show you have the distribution network available to handle that business. Another issue you should cover is how you will interact with associations to the program's benefit.

AA&B: What other matters does a program proposal usually address?

GT: You have to address the competition and where you fit in. If you don't demonstrate knowledge of the competition and show how your product will fit in successfully without inordinately exposing the carrier, then your proposal will not be taken seriously.

AA&B: How often are you required to share risk when starting a new program?

GT: Certain carriers absolutely require it; others don't. Most won't go so far as to require the risk-sharing to take the form of a captive. Some program insurers, however, pay commissions on a sliding scale, in which compensation varies according to the profitability of the program. Many carriers don't require a program administrator to share in underwriting risk at all.

AA&B: How long does it usually take to create a new program, from the time you submit a proposal to an insurer to the time you start writing business?

GT: In the case of the program I previously discussed, two-and-a-half years.

AA&B: Has the time frame been expanding or contracting?

GT: Over the past five to 10 years, I think it has gotten longer, because carriers have become more conservative. The amount of data that you have to assemble to persuade them a program is worthwhile has increased astronomically. We have put together new programs in six months, but realistically I think you're looking at a minimum of a year.

AA&B: Why did it take so long for the program you previously mentioned?

GT: Because the retail agent who interested us in the program didn't have a very large book of business, and the program was in a niche that a number of carriers quite recently had pulled out of. So the questions we faced were, “What makes you guys so smart? How can you make money in this marketplace when so many national insurance companies have pulled out of it?” So we had to do an extreme amount of homework.

AA&B: Can you give me a rough estimate of how many markets exist today for new programs?

GT: The Target Markets Program Administrators Association, of which I am a member, has 30 program companies as members. There are probably another 10 insurance carriers that will do programs, so my best guess is about 40.

AA&B: How has that number changed over the last five years or so?

GT: I think the number decreased from 2000 to 2003, but in the last couple of years has been on the rise.

AA&B: Do you expect to continue to see new capacity entering the program-business market?

GT: I think as long as insurance companies are posting solid results, which so far they seem to be doing this year, you will see a continued rise in program capacity.

AA&B: When you set up a program, obviously a contract is created between you and the insurance company. What are some of the issues that should be addressed in that contract?

GT: One key issue is the exclusive right to market a program. Most carriers are adamantly opposed to granting it. Still, if a program administrator does a good job for a carrier in a certain niche, it's not in their best interest to drop you. If they do, you can often go to another carrier and be successful, because the distribution network identifies you as the market more than the carrier itself. If you do a poor job, on the other hand, you're probably going to lose the contract anyway. Many program administrators think exclusivity is extremely important. I think that as long as you're dealing with honorable people who see you doing a good job, you'll be OK.

AA&B: How about the ownership of the program itself?

GT: That's an intellectual property issue. Usually we sign a confidentiality agreement with the market that essentially says any information we get from it is their intellectual property and anything we give to them is our intellectual property. That gives us some protection. We also put our own brand on all of our products–we never use the name of the insurance company–so again, the distribution network identifies us as the market. Also, just as a retail producer's contract does, program administrators' contracts give them ownership of records and expirations, which prevents insurers from using that information to go around program administrators.

AA&B: In the contract, do you attempt to address the issue of how much notice an insurer must give you before terminating a program?

GT: Carriers used to grant anywhere from six months to a year but have become much more restrictive. Most carriers don't want to give you more than 90 days. That's a major problem, because 90 days isn't enough time to replace a carrier. So this is often a sore point in contract negotiations with carriers. We often are able to get up to 180 days, but you never see it go beyond that.

Also, 90 days–or 180 days–is for “not for cause” cancellation. But there also is termination for cause. An insurer may say if your loss ratio exceeds a certain figure, the program can be terminated in 30 days. You spend a lot of time negotiating the “for cause” cancellation clause as well as the “not for cause” clause.

We try to limit the conditions under which a carrier can immediately terminate a program to our insolvency or to instances in which it can be proved that we've done something fraudulent. Carriers also often want the right to immediately terminate a program if a program administrator violates the underwriting guidelines. But almost everyone violates the underwriting guidelines in some minor way from time to time. It's almost inevitable. You miss something, or whatever. So we attempt to limit the carrier's right to terminate to instances in which we materially violate those underwriting guidelines; in other words, to those instances in which we've done something that could significantly increase the carrier's risk.

AA&B: What other key issues must be nailed down in a contract?

GT: A major issue is whether your compensation is in line with the duties you're going to perform. That's always the last thing that gets negotiated and is always the most difficult . If the carrier has a profit-sharing agreement, working out the percentage of the profits you receive is a major issue. We often spend a lot of time on that.

If a carrier terminates a program, how the runoff is handled is a major concern to us. After a carrier ceases to do business with a program administrator, there are still endorsements, cancellations, reinstatements, etc., that have to be handled. A lot of carriers want to take over the runoff of business, and that makes us extremely nervous. Our concern is that the departing carrier may not do this work very well, which would harm our relationships with our producers. So we want to make sure that the agreement gives us control over the runoff of business in the event of termination, as long as we're doing the job satisfactorily.

In the most recent hard market, you didn't have much choice in this matter (or many others). Carriers sort of took a take-it-or-leave-it attitude. Newer contracts are likely to be more flexible. The argument we often try to make is: “It's not that we don't trust you guys, but what if Genghis Khan becomes your next CEO, and he decides to invoke these clauses unreasonably and, in effect, puts us out of business? That's not fair and we think you should give us some concessions.” With such arguments program administrators often can get some relief on this issue but rarely to the extent they think necessary.

AA&B: Do contracts typically give program managers responsibility for loss control or claims adjustment?

GT: That varies greatly. Some program administrators don't handle claims and loss control; some do one or the other, or both. We provide some of the loss control but we handle none of the claims. If you have an in-house claims operation, then you can do deals only with insurance carriers that will allow you to use it. That means there will be insurance carriers you can't even consider using, because they will insist on using their own in-house claims people.

AA&B: For the programs that you underwrite, what kind of oversight do the insurers provide? How are audits conducted and how often do they take place?

GT: We're paperless, and our carriers can access our files electronically. We actually have carriers that audit us– sometimes we don't even know when they're doing so–on a 24/7 basis. More often, however, carriers prefer to do onsite audits, usually twice a year and sometimes three times a year.

AA&B: How do you expect the market for new programs to change in the coming year?

GT: I see the market slowly softening–at least in my end of it, which is the specialty niche. As long as that continues, I think it will become easier to do new programs, but that doesn't mean that it won't still be difficult.

AA&B: Any other important issues to address in creating a new program or insuring its success?

GT: You have to be sure that you have a niche and a plan that can reasonably be expected to produce an underwriting profit for the insurance company. If you don't have that but still somehow persuade an insurer to do business with you, you will burn the carrier with losses, and it will damage your reputation and limit your options in the future.