Producer used reinsurance companies - Hugh`s views

Producer used reinsurance companies - Hugh`s views

Hugh Rosenbaum reevaluates his suspicion of PORCS and determines that in some cases they definitely have a role to play Aptly named PORCS stands for producer-owned reinsurance companies. Some include them in the count of captive insurance companies (I never did). In the past I have inveighed against them as being parasites on the main stem of the insurance business and imposters in the listings of captive insurance companies. The current hard market conditions and fronting problems have brought a number of new inquiries from agents wanting to do something about the capacity problem, or the fronting problem, by starting something on their own. The kind of questions they are asking me is not how much can we make?, but will it help me find more capacity, fronting or coverage? Maybe it's time for me to re-evaluate some PORCS, or agency-owned reinsurers. Where value is added in the form of underwriting, they might well have a role to play. Underwriting 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 is acceptable to the buyer, acceptable to a reinsurer and, in the captive arena, 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 insurers willing to write the business, solvent and especially if it keeps the insureds covered, then these agents are providing a valuable service. I can even swallow the 50 to 60 per cent expense ratios that all this sometimes results in, for some kinds of labour-intensive program business, if hard-market conditions are being mitigated by the agent as underwriter. Underwriting, in other words, is worth a lot and its main value is in what doesn't happen, meaning bad risks accepted or insurers not being able to meet their obligations. Its secondary value is in what does happen in the form of lower loss ratios. It is clear to me that part of this underwriting service, or value-added to it, is doing the same for the insurer verifying its solvency and statutory standing as well as keeping an eye and ear on the claims and legal departments to understand trends or tendencies that could lead to sell-out, merger, or even liquidation. And being willing to do something for the client group of insureds before these things happen. Good underwriters, if insurers, are known to switch blocks of their business, and not just for reasons of higher commissions. Rewarding underwriters In my view, the underwriter ought to be the one rewarded most for the kind of business we are talking about. 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 judgement, the brainpower, and sometimes the basis for business continuity of the group of insureds. That is more valuable on the buyer's side than the financing, or spread-loss pooling provided by the insurers. 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 the percentages 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 add to an inquiring agent about starting a new PORC include: - Is your agency good at underwriting the book of business they send to their carriers? Do they really know about the 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? - Are the other agents you are thinking of joint-venturing with equally capable and willing to participate in this longer-term venture? The bigger picture I also think there is a bigger issue to be put on the table, here. That is 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 per cent 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.

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