INSIDE RELIANT GENERAL INSURANCE

November 2005

So you think you know all about how general agencies operate. Think again. Here is an exclusive question-and-answer conversation with Reliant General Insurance Agency owner Dana Dodds. Times have changed since the late 80's when a G.A. could be operated with a decent computer system and a P.O. Box. Read on....

Question: “ In your opinion, why do some general agencies go through so many carriers in a relatively short period of time? Is it due to loss ratio, reserves, reinsurance treaties, audit discrepancies etc.?

Answer: It has been our experience that when a carrier leaves a market, it is primarily due to loss ratio. The speed at which they exit depends on the individual company and it’s specific appetite for risk and ability to struggle through the down times to make it into profits. The longevity is most times a function of surplus, existence of reinsurance, faith in the wholesaler, and to a lesser degree, other events going on at the individual carrier (overall results for the carrier, executive management, rating agencies, etc.).

While a carrier may leave for loss ratio reasons, it is not necessarily the loss ratio of an affected program. For example, we started writing business with TIG in 1995. TIG took the risk net and we had 8 excellent years. We produced strong underwriting returns year in and year out. It was a good time in the market and we did a good job. Unfortunately, our business with TIG was, at most, 10% of their annual written premium. When Fairfax bought TIG, they ended up shuttering the entire operation due to poor results on an overall basis. This included the Reliant General program as well. We moved it to Chartwell, part of The Trenwick group, which was in an acquisition mode. They had made several purchases where the results were not as expected. With capital used to acquire business, and results not being strong, stock prices dropped, cost of capital increased, then rating agencies hammered the group due to results. This can start a vicious cycle where once the rating changes, the renewals drop, the new business dries up and the downward spiral begins. Throw in a 9/11 event and the chance for survival is eliminated. We are now starting our third year with Occidental and enjoy the relationship.

I have never seen a company leave due to inadequate reserves. In my experience, reserves are an interesting tool. They are used to squirrel away profits when times are good, and subsequently lowered when the current results are not within expected ranges. Reserves are a double-edged sword in that over-reserving can cause unnecessary heartburn in the short run, but can serve as a buffer over the long haul. At the same time, under-reserving can only result in bad things for a carrier. We have never been involved with a company that chronically under reserved, and conversely, we have written for companies that leaned on development numbers harder when it was time for profit sharing. In all cases, reserving has never been a reason for a company staying or leaving.

Reinsurance contracts, for those companies that cede some risk off, are a large part of the transaction. Keep in mind some companies are heavy users and some that are marginal utilizers of reinsurance. It’s been my experience that for those companies that use heavy reinsurance, it is for 2 main reasons; they are looking to make money on fees, or they want to write the business but want to participate to a lesser extent until their comfort level grows.

Why do some companies stay for so long and others leave? Great question. Things may not be as they appear. Some companies make a commitment to a market and stay. In the wholesaler distribution environment, it generally means that a carrier (and/or reinsurer) believes in the wholesaler and knows any changes that need to be made will occur. At the same time, some carriers have survived for many years, yet have never turned an underwriting profit. These companies have been famous for fronting deals and their longevity lies in the ability to renew reinsurance treaties. As long as reinsurance is renewed, they will be in the market. That being said, why do reinsurers renew on business they lose money on? I just don’t know, but they do. Reliant General is a relatively new entrant into the reinsurance community. For the first 10 years we were in business, our carriers went net or arranged all the reinsurance placements. Apparently there are some things we need to learn – but I still don’t know why reinsurers take on losing books of business, either new or renewal.

Last but not least, if a carrier that has been writing this line of business in other states, or used other wholesalers, suddenly exits, it is usually due to something occurring in the wholesaler/carrier relationship. If a company leaves right after starting a new program, there has not been enough time for losses to develop, which points to relationship issues. We have never had a carrier leave the market due to an audit discrepancy.

Question: “Is it true that current treaty agreements that involve general agencies get from carriers are not very profitable? What other forms of income can a general agency earn (i.e. contingency, claims, etc.)?”

Our experience is that reinsurance deals are not very profitable on the front end. The real money is made based on the profitability of the program. A typical reinsured program provides for all other parties to be paid first, and then the wholesaler is paid. We could get into the reasons, but suffice it to say that many reinsurers were taken advantage of in the late 90s and early 2000s. Current programs are paying that penalty. Much of the reinsured business was wholesaler produced, which resulted in all similar distributions being painted with the same brush. In fact, some reinsurers we talk to will not reinsure business produced through this channel. Truth be told, this is understandable, as there exists the potential for abuse when the wholesaler is paid based on volume alone.

This past month, it seems I have spent more time traveling than at home. All of it spent on renewing our reinsurance contracts for one of our programs. 80% of our time has been spent on talking about the weather – and any time you talk weather with reinsurers, the weather has a name - Katrina. And if you really want to see reinsurers go pale, ask them what their exposure was to Rita. But that’s just plain mean, and if you want to renew your reinsurance, you use good manners. It has been estimated in leading trade magazines that 20% of the insurance industry surplus is going to disappear as a result of Katrina, Rita and Wilma. Almost every reinsurer we saw was doing 2 things; raising reserves on wind losses and raising capital. What does this have to do with renewing a nonstandard auto program in California? Everything! There is not one reinsurer I have spoken with in recent days that did not have exposure to this event. As a result, it enters into all facets of the reinsurance company, whether it be renewals or new business. If the reinsurer took a large loss in Katrina, it needs to recoup these losses. If they raised capital, the return requirement on that capital is greater. Since everyone is raising reserves and capital, the talk is long on rates going higher in most cases. We have seen three approaches in response to heavy losses in the reinsurance community;

Some reinsurers are moving forward as is. They realize the events as shock losses and know that in time, if they write this business, they will have losses. Their pricing for renewal and new business does not change dramatically.
Some reinsurers are raising their rates. By that, I mean they are pricing their reinsurance with higher rates of return required. They apply this across the board for all programs. As a result, a program that required a 10% return last year now requires a 12% return. Where does this return come from? Lower permissible loss ratios. If your loss pick (the loss ratio you are underwriting to) does not contemplate the higher rate of return required, you must raise rates or accept lower commissions.
Some reinsurers are saying they need to balance their book better, between catastrophic exposures and more stable business. As a result, they are pricing business based on the exposure (imagine that, applying a price to the exposure). So on more stable business, they will be happy at a much lower rate of return, because it is a dependable return. It’s very similar to the way people invest. Some go high-risk, high-return potential and others go for low risk, steady returns.

The underlying theme is that there is a cost to capital and reinsurers will underwrite programs that fit their individual requirements. At the same time, some reinsurers are bottom-feeders. They charge higher rates because they can. Since so many reinsurers have been burned in the past, they have no qualms about maximizing returns while they can. In our experience, most reinsurers fall somewhere in the middle. They are in the market because the opportunity for making money in this line is greater than other areas. If it happens to pinch some participants through low ceding commissions, so be it.

A common conversation we have is where the reinsurer states that they will provide a ceding commission that just covers costs, with the real money made at profit-share time. Yet when we ask them how many profit share checks they have delivered over the past 3 years, they have trouble naming more than 1 or 2. At the same time, results for the reinsurers and front companies are very strong. This tends to indicate the market is a bit out of balance and will adjust to more favorable terms for all players. When this will happen is anyone’s guess.

As to other forms of income to a wholesaler, there are very few. Some sell motor club products, which can add some revenues. Other get some interest earnings from premiums held prior to carrier remittance. Motor club is an interesting topic. While Reliant General offers a motor club, sometimes an evaluation of the motivation can reveal some interesting information. Our stance has always been that we will offer motor club in those cases where our producers want it or it provides a method for us to comply with DOI regulations. As such, we have never used motor club as a profit tool. Carriers and reinsurers are quick to discuss all revenue sources to a wholesaler. Motor club can be a tool to boost wholesale revenue, depending on its’ usage. But the fact remains that an insured may not know how much they are paying for insurance versus motor club. Many times, all they know is what the monthly payment is. If the wholesaler prices a program to include a motor club, there is a temptation to load the motor club as a high revenue product, perhaps replacing what they have lost in the upfront commissions. What has really happened in these cases is a shifting of dollars. If more dollars go to motor club, there are less available to pay claims. You do the math. This same philosophy can be applied to policy fees.

Question: “In your opinion, why don’t some carriers stay in the nonstandard business over the long haul and ride through the shock loss and high claim severity period? Is this due to limited reserves and they have no choice?”

Some carriers lack the commitment to any market. And you can’t always blame them. In a prior life, I worked for a carrier whose commitment was to making an underwriting profit. That is a reasonable goal. If we don’t go to work to make money, why go? This same carrier did not view longevity in the market as a mandatory ingredient to success. When I started with this company, they were 80% in one commercial line, switched to a blended multi-peril commercial lines book, added personal lines through wholesalers and then direct from the company, and ended up with blended distribution across several lines. Through it all, they have retained their A rating and continued to make a reasonable return when applied to the cost of capital. It is my observation that they pursued the best chances of return, wherever it lay. Granted, some lines require longevity to succeed, and this company responded accordingly, but commitment to a market was not necessarily as strong a factor as retail producers would want.

The reason it seems wholesalers seem to get these type of relationships more frequently is due to the economics. If a carrier decided they wanted to try nonstandard auto, they would have to spend a lot of capital just to get started. As a result, their capital outlay getting started would delay the realization of profits. At the same time, they would need to learn how to control costs, which is really the key to making money in a commodity business. In an effort to control costs and save money, they may turn to a wholesaler. We have the infrastructure and years of experience operating at lower margins. As an aside, I enjoy giving tours of Reliant General to carriers that are considering going direct into California. We show them what they will need to do to compete. It can be a sobering experience for those people that think all you need is a product, a marketing rep, and an underwriter. At the same time, these same companies that utilize the wholesale distribution model can exit much easier as opposed to those that have spent time and money to generate the needed returns. Unfortunately, when a carrier has less invested, it can be easier to quit.

Over the past 5 years, we have had to evolve into a company that can perform all the tasks of an insurance company. To be honest, we have to perform even better because we are a wholesaler. We need to be able to talk in great detail about frequency and severity trends, legislative and regulatory issues, XPO/XCO covers, case-reserving versus average loss reserving philosophies, capital costs versus surplus notes, Bermuda cell captives and the tax ramifications, etc. etc. All to say that the business has changed from 15 years ago where if you had a good reputation and an IBM XT, you too could be a wholesaler (or so it seems). Or 7 years ago, if you had a good story and could point out California results, you too could get reinsurance.

It still comes back to loss ratio. A sophisticated wholesaler manages the loss ratio, doesn’t cheat on the underwriting side, and produces profits for its’ partners. While the California market is tougher on the wholesalers, it is resulting in improvements. It is my experience that the current competitors are much smarter, more sophisticated, and are working toward underwriting profits for their carriers.

There is a new model emerging that may provide more stability in the wholesale nonstandard arena. With companies getting more sophisticated, they posses the necessary skills to perform all functions of an insurance company. At the same time, getting a certificate of authority in California is an arduous process. Some wholesalers are taking the step of forming their own reinsurance companies in places like Bermuda, and reinsuring the business they produce, even as they serve as wholesaler. This aligns all interests in the transaction (except for retail production) and also allows for some incredibly favorable tax treatment of profits. For those companies moving in this direction, they add additional stability to products distributed through wholesalers.

Question “Do some treaties require that the carrier participate in the fee income?”

I have not seen any contracts where the carriers participate in the fee income. I have heard of this, but I have no firsthand knowledge of this occurring. I have seen contracts where the portion of fees subject to premium tax are considered in the contract, but only to the exited that the fees add premium tax (i.e. policy fees).

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