Dealing with Troublesome Terms in Carrier Contracts

This article was derived from Mr. Thompson's presentation at the Fifth Annual Target Markets Program Administrators Summit, which was held in October in Tempe, Ariz.)

WORDS mean things–especially when it comes to contracts. That's why it's essential that program administrators give more than cursory attention to their contracts with insurance companies. Depending on how a contract is worded, it can pave the way for a mutual profitable experience, or it can leave the program administrator more or less at the mercy of the carrier.

Contracts between carriers and program administrators contain a host of conditions and terms. In this article, I'll discuss a number of them and provide suggestions for negotiating a contract that will be an asset to your program.

Suspension: Watch out for provisions under which the carrier could suspend your underwriting authority. “Suspension” seems less terrifying than “termination”; it sounds only temporary. But suspension can give a carrier a “below the radar” way to put you out of business. Try to limit its application to the greatest degree possible.

Termination: A carrier typically wants the flexibility to terminate the contract with little or no notice. Among the grounds for termination it may wish to include are the following:

• Any violation of the carrier's guidelines.
• A combined ratio exceeding 100% in any underwriting year.
• An unapproved change in the ownership or control of a program administrator's business.
• The carrier's loss of reinsurance.
• The cancellation, suspension or declination of the program administrator's license in any state.
• Any change in laws or regulation that affects the carrier's exposures.

A program administrator, on the other hand, should ask the carrier to provide as much notice as possible in case of termination, suspension of underwriting authority, change in underwriting guidelines, or change in premium rates or coverage. In regard to grounds for termination, a prudent program administrator should negotiate for:

• A specified time period in which the program administrator can “cure” any errors or license cancellations.
• A provision stating that the cancellation of a license in one state will not affect the program administrator's ability to do business in others.
• A reasonable definition of what would constitute a change of control of a program administrator's operations. It's also wise to include a requirement that the carrier's acceptance of a change in the program administrator's ownership or key officers “shall not be unreasonably withheld.”
• A requirement that the carrier exclude any catastrophe losses when calculating a combined ratio for purposes of determining if a program has failed to meet a target.
• In regard to the loss of reinsurance, a requirement that the carrier give the program administrator advance notice and make a good-faith effort to replace it.
• A requirement that any change in a law or regulation that a carrier invokes to terminate a contract have a major, material impact on the carrier's exposures.

Exclusivity: Many program administrators want exclusive relationships with carriers, but I'm not sure that's desirable. Remember that most carriers are not going to give you a one way exclusive: they will insist on it being mutual. Also, an exclusive is of little consequence unless there is at least a six months notice of withdrawal. What if the carrier loses its Best's rating? For a year, you may have to continue using a carrier that has a “B”rating or worse. What if your carrier significantly changes its underwriting guidelines? Or maybe it has a rogue actuary who decides that your program's rates need to double? You start to lose a lot of business. If you've given the company an exclusive, you're stuck for either the exclusive notice period or for the life of the contract.

We once had an exclusive with Frontier Insurance Co. that required us to give the carrier a year's notice to move the program. As we all know, Frontier filed for bankruptcy. Thank God, we also had a provision in the contract waiving the required notice period if the carrier's Best's rating was downgraded. Because of it, we were able to move the program before the situation became critical.

You can address some of these issues with contract conditions, but will carriers agree to them? In today's market, they often won't.

An exclusive is not always so great for an insurer, either. It can saddle the carrier with a program administrator who's not getting the job done–but is not performing so badly that the carrier has grounds to terminate the contract on short notice. So I think a mutual exclusive with a lengthy notice requirement has drawbacks for both parties.

I prefer a “de facto” to a “de jure” exclusive. We simply agree with the carrier that we will both act as if we have a mutually exclusive as long as both sides are basically satisfied with the relationship. I've found that when a carrier doesn't honor a handshake agreement to give us an exclusive, we've been able to depart and retain the vast majority of the business. (I make sure contractually that we own the program's records and expirations.)

Also, contracts aside, it's increasingly important these days to underwrite your carrier partners. No contract is tight enough to protect you from somebody who is difficult or unethical.

Insurer-specific trust accounts: Program administrators should, of course, separate their operating funds from those held in trust for their carriers. But insurers increasingly want program administrators to create separate trust account for their business. That's not a problem if all your business is with one carrier; otherwise, it's a real headache. Certain states require separate trust accounts, but many permit program administrators to deposit collected premiums (net of commissions) for all carriers in single trust account. A program administrator operating several programs constantly receives checks from retail agents, which contain premium payments for multiple companies. It's certainly a lot easier to deposit these checks into one trust account than break them into payments for each carrier as the checks come in.

Rather than create a separate trust fund for a carrier, a middle ground is to create a joint account

Then, on a given date, you can transfer into it the carrier's accumulated premiums from the single trust account, and it can sweep them out. The parties can work out the terms of the joint account, including when the program administrator would be required to move funds into it.

Ownership of claims data: A carrier may want a contract provision granting it the exclusive ownership of the program's claims data, and requiring the program administrator to ask for the carrier's permission before using it. The usual intent of such a provision is to bar the program administrator from using the data to get another carrier. I'm not a lawyer, but I question whether this provision is enforceable. As a program administrator, I need this information to conduct my business. But rather than challenge such a provision in court after a carrier invokes it, a better idea is to try to negotiate the provision out of the contract at the outset. For instance, you can suggest joint ownership of the data, or a provision requiring you to notify the carrier if you show the data to other parties.

Run-off provisions: In the event that a carrier stops writing new business and the program goes into run-off, who services the business? Some contracts give that authority to the carrier. What if they do a terrible job of processing endorsements for policies in run-off? The program administrator's relationship with its retail agents and their insureds could be irreversibly damaged. I've also seen provisions requiring program administrators to return any unearned commissions at the termination date of the contract. That fits into the “you've got to be kidding me” category.

We want the contract to give us the authority to run off the business, as long as we adequately perform our duties. As part of that, we want it made clear that we have endorsement authority. I've seen contracts that require a program administrator to get the carrier's approval for every endorsement issued during a run-off. But when your program is in the process of being closed down, you often don't get much cooperation from the insurer, and the requirement becomes a nightmare.

It came from left field: I've seen bizarre contract provisions. Here are a few of them to avoid:

• You die, you lose: A provision giving the insurer the right to terminate the contract immediately in the event of the death of the program administrator's CEO. So if I have the bad manners to kick the bucket, my estate loses everything I've worked for.
• “Cassandra” clauses: I once saw a contract provision requiring me to notify the company 30 days before the carrier is cited by any regulatory authority or we would be responsible for any fines resulting from the violation.
• Responsibility for reinsurance uncollectibles: A company may try to make a program administrator 100% responsible for any uncollectible reinsurance, even if any negligence on the part of the program administrator was only contributory.
• Lopsided hold-harmless agreements: Some hold-harmless agreements require a program administrator to indemnify a company for its negligence as well as the program administrator's. Hold harmless agreements should be equal. In so many words, they should say, “I'm responsible for what I mess up; you're responsible for what you mess up.”
• Audit guarantees: If you can't collect on a premium audit, you should always have the right to return it to the company within a specified time (45 days is typical) which will take you off the hook on the audit premium although, naturally, you will lose your commission on the transaction. But I've seen contracts requiring program administrators to guarantee collection.

Responsibility for retail agents: A contract may attempt to make a program administrator responsible for any willful or gross misconduct on the part of a retail agent that adversely affects the carrier. You could have your contract terminated because of something a rogue agent did. That's tough to live with.

Accounts-current terms: The number of days in which you have to pay your accounts current usually ranges from 30 to 60 days. We try hard to negotiate 60 days, given that most of our producers pay us on an account current basis, as opposed to cash with application.

Another issue is whether you pay accounts current by your statement or by the company's. One advantage of paying by the company's statement is that, if they are behind in coding, you may enjoy a few extra days of float. A disadvantage is that you have to reconcile to their statement, instead of having them reconcile to yours, so you have extra accounting work.

Compensation: When negotiating commission, program administrators also should negotiate who is going to be responsible for such things as inspections, audits, MVRs and credit reports. These things can become major expenses. It is also important to agree upon which party keeps the fees and and a range of how much is going to be charged. It's best to nail down these issues in advance, so there will be no surprises on either side. Sometimes negotiating compensation can seem like rug buying in a Middle-Eastern market. You may start a little high, the company may start a little low, and you end up meeting somewhere in the middle. My preference is to argue for a reasonable number based on the services rendered. While the standard program administrator commission is 20%, this can vary greatly according to the line(s) of coverage, premium size and the overall profitability of the program.

Managing your attorney: When you work with contracts, you need an attorney. Make sure you manage what the attorney does. It may sound cynical, but you have to remember that attorneys get paid for being inefficient. The longer they take, the more they can bill you. So you have to make sure your attorney stays focused on what is important to you. Avoid having your attorney negotiate directly with the insurer. A lot of people say, “Well, I'll just let the attorney negotiate the contract for me.” That can be a big mistake. I've seen attorneys drive the other side crazy over an issue that, at the end of the day, I was sure was of minuscule importance. Certainly, you want to talk to your attorney and get his or her feedback as negotiations progress, but the only time I let my attorney talk directly to the other party is when there's some detailed language that needs to be worked out. Then sometimes their attorney and your attorney can get together and expedite things.

The most troubling words you can hear from your attorney are, “We need to research that.” Usually, that means, “We just hired a law school grad who doesn't have enough to do. We're going to have him do about 40 hours of research on some obscure issue in your contract, and you're going to get a big bill for it.” I tell my attorneys, “If you're going to research something, I want to know what it is, and how much it's going to cost. Then I'll decide whether I want the research.”

Finally, never, never have an attorney write a contract from scratch. That's a recipe for disaster. I've heard of attorneys who write 200-page contracts from scratch that both parties wind up hating. So find a contract, any contract, and make the attorney use it as a starting point.

Negotiating a good contract is one of the keys to a program's long term success. It may seem unimportant when you are starting a relationship, but it can save your life when you are ending one.

Greg Thompson is president of Thomco Insurance, which he and his father founded in 1979. The company operates more than a dozen programs. Prior to founding Thomco, Mr. Thompson served on the faculty of the European Institute of Business Administration in Fontainebleau, France, and later joined Marsh and McClennan in New York. Mr. Thompson graduated cum laude with a liberal arts degree from Washington and Lee University and earned an MBA at the University of Virginia's Darden School. Readers can contact him at gsthompson@thomcoins.com.