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HUGH'S VIEWS ON AGENCY CAPTIVES

HUGH'S VIEWS: ISSUE 7: MAY 28, 2003

Background from captive.com:

Early in May 2003, we received an Ask the Expert Question that generated considerable interest. Because it was a "general interest" question that had been asked of us before, we posted it on our ASK THE EXPERTS page so visitors would have access to both the question and our expert's response. We got considerably more than we bargained for from our readers, though.

Here is the exchange:

Q: Is it possible to set up a captive with insurance agencies as the owners, to provide coverage for their own clients under this captive? What would be some questions to ask to start this process?

A: (by captive.com's own John Salisbury) Yes, you could establish a captive with insurance agencies as owners.

Three suggestions: (1) review the information that is already available on captive.com; (2) purchase the book, Captives and the Management of Risk by Kate Westover, available through the NewsRack at the captive.com website, published by International Risk Management Association; and (3) plan on 10-12 months of development time and do not try to do it on the cheap.

The cost for the feasibility study and implementation using experienced professionals will be in the $100K - $150k range. Skimping will have its consequences.

We invited opposing viewpoints, a couple of which are now available from the original question.

As things go, though, Hugh Rosenbaum became a bit more intimately involved the ensuing exchange. So compelling were his thoughts that we asked him to put pen to paper (or, rather, digits to keyboard) and expand a bit on what other elements are involved in agency captive formation, in addition to the basic answers given by John Salisbury. This article is the result -- inarguably brilliant, but sure to ruffle a few feathers (as usual):

There are some insurance agents that I would characterize as good underwriters, to differentiate them from the more basic order-takers and salesmen. From my point of view, underwriting is essentially:

  • Knowing a good risk from a bad one - in other words, knowing when to reject a prospect. This usually means a thorough grounding in the business and operations of the prospect, with emphasis on whether it is well managed, well regarded, and has at least some aspects of good risk management
  • Knowing how to interpret the information provided, and combine it with proprietary information or experience to know whether good risks are worth further study because they are "special"
  • Knowing how to rate those good risks in such a way that the rating isacceptable to the buyer, acceptable to a reinsurer, and, in the captivearena, acceptable to the other participants in a pooled-risk venture.

Those insurance agents who do the underwriting for their insurance carriers are in a position to deliver profits or losses to their carriers over time. The good ones maintain profitable books, and are rewarded with high commissions, profit commissions, and performance bonuses. In my view, if that's what keeps the business flowing in, and keeps the insureds covered, these agents are providing a valuable service. I can even swallow the 50-60% expense ratios that all this sometimes results in, for some kinds of labor-intensive program business, if hard-market conditions are being mitigated by the agent as underwriter.

In my view, the underwriter ought to be the one rewarded most for the kind of business we are talking about. What kind of business are we talking about? The kind of business that takes a good deal of underwriting skill (as I defined it above), and a lot of hands-on work with the original insureds, which sometimes results in better risk management. In my view, the underwriters of this kind of book of business ought to be the ones to directly benefit the most for its financial result.

The capital provider, sometimes erroneously referred to as the ultimate risk-taker, provides the financing for the pool of risks, but the underwriter provides the judgment, the brainpower, and sometimes the basis for business continuity of the group of insureds.

What strikes me as a shame is that the agents as underwriters are usually rewarded in the form of commissions or percentages, rather than on the basis of a share in the book of business. Under this system there is a reward for good results, and no reward for bad results - but no penalty, either. That kind of situation creates one kind of motivation to succeed, one that is constantly under threat of short-term interpretation of the long-term result. Wouldn't it be more logical for the underwriter agents to have an equity stake in the book of business, which means they would share in the downside as well as the upside? Time and again, I have seen first-hand how this kind of reward coupled with potential penalties creates a better kind of motivation to succeed over the long term, and dampens short-term enthusiasms or bright ideas.

So the points I would have added to the inquiring agent in the exchange above include:

  • Is your agency good at underwriting the book of business they send to their carriers? 
  • If so, are you willing to give up some of your commissions in exchange for some of the equity in the book of business?
  • And are the other agents you are thinking of joint-venturing with equally capable and willing to participate in this longer-term venture?

I also think there is a bigger issue to be put on the table here -- the issue of the credibility of the agency that has some "skin in the game" when they approach carriers, reinsurers, or even large potential clients. Which proposal looks better to you: the one backed by a discussion of the growing numbers of clients and millions of dollars of premiums written over the past five years, or the one backed by a disclosure that the agency has a 20% stake in the underlying insurance, which has demonstrated a conservative loss ratio over the past five years?

In these times of hard markets, those agents, and groups of agents, who have some of their own underwriting equity ought, in my view, to do better than the simple salesmen.




Hugh Rosenbaum, one of captive.com's friends and valued contributors, is a freelance consultant. Hugh can be reached by telephone at +4420 8883 6729 or by e-mail at 
[email protected]. Learn how you can spend a day with Hugh!

Visit Hugh's Captive Consulting and Music Websites at
http://www.hughro.com/


Background from captive.com:

Early in May 2003, we received an Ask the Expert Question that generated considerable interest. Because it was a "general interest" question that had been asked of us before, we posted it on our Ask the Expert Q & A page so visitors would have access to both the question and our expert's response. We got considerably more than we bargained for from our readers, though.

Here is the exchange:

Q: Is it possible to set up a captive with insurance agencies as the owners, to provide coverage for their own clients under this captive? What would be some questions to ask to start this process?

A: (by captive.com's own John Salisbury) Yes, you could establish a captive with insurance agencies as owners.

Three suggestions: (1) review the information that is already available on captive.com; (2) purchase the book Captives and the Management of Risk by Kate Westover, available through the NewsRack at the captive.com website, published by International Risk Management Association; and (3) plan on 10-12 months of development time and do not try to do it on the cheap.

The cost for the feasibility study and implementation using experienced professionals will be in the $100K - $150k range. Skimping will have its consequences.

We invited opposing viewpoints, a couple of which are now available from the original Ask the Expert question.

As things go, though, Hugh Rosenbaum became a bit more intimately involved the ensuing exchange. So compelling were his thoughts that we asked him to put pen to paper (or, rather, digits to keyboard) and expand a bit on what other elements are involved in agency captive formation, in addition to the basic answers given by John Salisbury. This article is the result -- inarguably brilliant, but sure to ruffle a few feathers (as usual):

There are some insurance agents that I would characterize as good underwriters, to differentiate them from the more basic order-takers and salesmen. From my point of view, underwriting is essentially:

  • Knowing a good risk from a bad one - in other words, knowing when to reject a prospect. This usually means a thorough grounding in the business and operations of the prospect, with emphasis on whether it is well managed, well regarded, and has at least some aspects of good risk management
  • Knowing how to interpret the information provided, and combine it with proprietary information or experience to know whether good risks are worth further study because they are "special"
  • Knowing how to rate those good risks in such a way that the rating isacceptable to the buyer, acceptable to a reinsurer, and, in the captivearena, acceptable to the other participants in a pooled-risk venture.

Those insurance agents who do the underwriting for their insurance carriers are in a position to deliver profits or losses to their carriers over time. The good ones maintain profitable books, and are rewarded with high commissions, profit commissions, and performance bonuses. In my view, if that's what keeps the business flowing in, and keeps the insureds covered, these agents are providing a valuable service. I can even swallow the 50-60% expense ratios that all this sometimes results in, for some kinds of labor-intensive program business, if hard-market conditions are being mitigated by the agent as underwriter.

In my view, the underwriter ought to be the one rewarded most for the kind of business we are talking about. What kind of business are we talking about? The kind of business that takes a good deal of underwriting skill (as I defined it above), and a lot of hands-on work with the original insureds, which sometimes results in better risk management. In my view, the underwriters of this kind of book of business ought to be the ones to directly benefit the most for its financial result.

The capital provider, sometimes erroneously referred to as the ultimate risk-taker, provides the financing for the pool of risks, but the underwriter provides the judgment, the brainpower, and sometimes the basis for business continuity of the group of insureds.

What strikes me as a shame is that the agents as underwriters are usually rewarded in the form of commissions or percentages, rather than on the basis of a share in the book of business. Under this system there is a reward for good results, and no reward for bad results - but no penalty, either. That kind of situation creates one kind of motivation to succeed, one that is constantly under threat of short-term interpretation of the long-term result. Wouldn't it be more logical for the underwriter agents to have an equity stake in the book of business, which means they would share in the downside as well as the upside? Time and again, I have seen first-hand how this kind of reward coupled with potential penalties creates a better kind of motivation to succeed over the long term, and dampens short-term enthusiasms or bright ideas.

So the points I would have added to the inquiring agent in the exchange above include:

  • Is your agency good at underwriting the book of business they send to their carriers? 
  • If so, are you willing to give up some of your commissions in exchange for some of the equity in the book of business?
  • And are the other agents you are thinking of joint-venturing with equally capable and willing to participate in this longer-term venture?

I also think there is a bigger issue to be put on the table here -- the issue of the credibility of the agency that has some "skin in the game" when they approach carriers, reinsurers, or even large potential clients. Which proposal looks better to you: the one backed by a discussion of the growing numbers of clients and millions of dollars of premiums written over the past five years, or the one backed by a disclosure that the agency has a 20% stake in the underlying insurance, which has demonstrated a conservative loss ratio over the past five years?

In these times of hard markets, those agents, and groups of agents, who have some of their own underwriting equity ought, in my view, to do better than the simple salesmen.

Background from captive.com:

Early in May 2003, we received an Ask the Expert Question that generated considerable interest. Because it was a "general interest" question that had been asked of us before, we posted it on our Ask the Expert Q & A page so visitors would have access to both the question and our expert's response. We got considerably more than we bargained for from our readers, though.

Here is the exchange:

Q: Is it possible to set up a captive with insurance agencies as the owners, to provide coverage for their own clients under this captive? What would be some questions to ask to start this process?

A: (by captive.com's own John Salisbury) Yes, you could establish a captive with insurance agencies as owners.

Three suggestions: (1) review the information that is already available on captive.com; (2) purchase the book Captives and the Management of Risk by Kate Westover, available through the NewsRack at the captive.com website, published by International Risk Management Association; and (3) plan on 10-12 months of development time and do not try to do it on the cheap.

The cost for the feasibility study and implementation using experienced professionals will be in the $100K - $150k range. Skimping will have its consequences.

We invited opposing viewpoints, a couple of which are now available from the original Ask the Expert question.

As things go, though, Hugh Rosenbaum became a bit more intimately involved the ensuing exchange. So compelling were his thoughts that we asked him to put pen to paper (or, rather, digits to keyboard) and expand a bit on what other elements are involved in agency captive formation, in addition to the basic answers given by John Salisbury. This article is the result -- inarguably brilliant, but sure to ruffle a few feathers (as usual):

There are some insurance agents that I would characterize as good underwriters, to differentiate them from the more basic order-takers and salesmen. From my point of view, underwriting is essentially:

  • Knowing a good risk from a bad one - in other words, knowing when to reject a prospect. This usually means a thorough grounding in the business and operations of the prospect, with emphasis on whether it is well managed, well regarded, and has at least some aspects of good risk management
  • Knowing how to interpret the information provided, and combine it with proprietary information or experience to know whether good risks are worth further study because they are "special"
  • Knowing how to rate those good risks in such a way that the rating isacceptable to the buyer, acceptable to a reinsurer, and, in the captivearena, acceptable to the other participants in a pooled-risk venture.

Those insurance agents who do the underwriting for their insurance carriers are in a position to deliver profits or losses to their carriers over time. The good ones maintain profitable books, and are rewarded with high commissions, profit commissions, and performance bonuses. In my view, if that's what keeps the business flowing in, and keeps the insureds covered, these agents are providing a valuable service. I can even swallow the 50-60% expense ratios that all this sometimes results in, for some kinds of labor-intensive program business, if hard-market conditions are being mitigated by the agent as underwriter.

In my view, the underwriter ought to be the one rewarded most for the kind of business we are talking about. What kind of business are we talking about? The kind of business that takes a good deal of underwriting skill (as I defined it above), and a lot of hands-on work with the original insureds, which sometimes results in better risk management. In my view, the underwriters of this kind of book of business ought to be the ones to directly benefit the most for its financial result.

The capital provider, sometimes erroneously referred to as the ultimate risk-taker, provides the financing for the pool of risks, but the underwriter provides the judgment, the brainpower, and sometimes the basis for business continuity of the group of insureds.

What strikes me as a shame is that the agents as underwriters are usually rewarded in the form of commissions or percentages, rather than on the basis of a share in the book of business. Under this system there is a reward for good results, and no reward for bad results - but no penalty, either. That kind of situation creates one kind of motivation to succeed, one that is constantly under threat of short-term interpretation of the long-term result. Wouldn't it be more logical for the underwriter agents to have an equity stake in the book of business, which means they would share in the downside as well as the upside? Time and again, I have seen first-hand how this kind of reward coupled with potential penalties creates a better kind of motivation to succeed over the long term, and dampens short-term enthusiasms or bright ideas.

So the points I would have added to the inquiring agent in the exchange above include:

  • Is your agency good at underwriting the book of business they send to their carriers? 
  • If so, are you willing to give up some of your commissions in exchange for some of the equity in the book of business?
  • And are the other agents you are thinking of joint-venturing with equally capable and willing to participate in this longer-term venture?

I also think there is a bigger issue to be put on the table here -- the issue of the credibility of the agency that has some "skin in the game" when they approach carriers, reinsurers, or even large potential clients. Which proposal looks better to you: the one backed by a discussion of the growing numbers of clients and millions of dollars of premiums written over the past five years, or the one backed by a disclosure that the agency has a 20% stake in the underlying insurance, which has demonstrated a conservative loss ratio over the past five years?

In these times of hard markets, those agents, and groups of agents, who have some of their own underwriting equity ought, in my view, to do better than the simple salesmen.