As reinsurers are turning increasingly to writing direct insurance in the US, Clyde Owen looks at the opportunities outsourcing offers to managing the business.
Reinsurers are writing more direct business in the US, both to accommodate their customers and to develop new profitable markets. According to figures from the Washington, DC-based Reinsurance Association of America (RAA), in 2002 reinsurers wrote $3.82bn of direct premiums in the US. This was the first year the RAA had tracked direct premiums. In the first quarter of 2003, reinsurers wrote $1.11bn in direct premiums, indicating a continuing upswing.
But few reinsurers are fully equipped to manage direct business because they lack both the requisite staff and technology. Most reinsurance executives underestimate the complexity of direct business and amount of knowledge required to play this new game. For example, reinsurance companies don't normally have the information systems needed to efficiently manage the interface with managing general agencies (MGAs) that sell direct programs. Without the right technology, a program can go awry and the reinsurer may not know it until it's too late, when the losses start mounting. Direct insurers must comply with an ever-changing complex set of rules because each of the 50 states has different insurance laws, regulations and reporting requirements. What's more, failure to comply can result in hefty fines. Most US-based reinsurers aren't fully aware of all these issues; European reinsurers find it even more difficult to keep tabs.
However, writing direct business is often a necessity for reinsurers, and it can provide competitive advantages. By taking on direct business, the reinsurer gains more intimate, street-level knowledge of a program and can forge tighter partnerships with MGAs and direct carriers.
There are technology solutions that can help reinsurers manage their business cost-effectively and efficiently by tapping into the expertise of vendors specialising in the US insurance market. Solution choices broadly include outsourcing all IT functions, outsourcing some functions while handling some in-house, or buying a policy-management system.
Several trends are driving reinsurers to write more direct business. Sometimes, the business comes in by chance. A client may go out of business completely or drop a certain line of business - an increasingly common move spurred by the hard market. For instance, the primary carrier may not want to write long-haul truckers anymore. The reinsurer steps in and writes the business. Writing direct can help clients in other ways. Let's say the carrier is launching a program for an association or a business group, but it is not licensed in several states. Instead of waiting until it gets those licenses, it sends the business to the reinsurer's primary subsidiary, which is licensed in those states and can write the business immediately.
On the other hand, more reinsurers are actively seeking direct business. For example, an MGA may propose a program in a class of business that historically has been very profitable. Instead of profiting only on the reinsurance portion, the reinsurer participates on the front-end as well by taking on a portion of the direct business.
To handle direct business, most reinsurers own licensed primary insurance companies that they hold as 'shells' and can deploy as fronting companies to write direct business. That meets the states' minimum legal requirements, but that's all it does.
Becoming expert in US direct insurance takes many years if a reinsurer tries to do it from scratch. It takes a huge body of knowledge and a solid technology infrastructure to successfully write each line of business in each state. It might be writing printing plants in California and New York, or Baptist churches in the South. It might be underwriting lines as diverse as workers' compensation, motor vehicle insurance, and professional liability coverage for doctors or architects.
Unlike reinsurers, primary carriers have many fiduciary responsibilities to their policyholders. States set rules regarding when insurers are allowed to cancel, non-renew and reinstate policies in complex, bureaucratic lines such as workers' compensation and motor vehicle insurance. For instance, a reinsurer covering motorists in diverse markets such as Tennessee, Arkansas, Idaho and Alaska must comply with completely different rules imposed by the department of motor vehicles (DMV) in each of those states. Direct insurers must provide DMVs with the exact information they require, in an approved format, and at the appropriate times. Companies that don't comply with even the smallest details can be hit with stiff by-the-day fines.
It's crucial to have up-to-date, accurate data, including the vehicle identification number for each insured vehicle. If a properly insured customer is pulled over by the police for a routine check and his or her vehicle erroneously comes up as uninsured on the state's database, the vehicle can be impounded on the spot. It doesn't make for good customer or agent relations, and there's the potential for public backlash when customers take their stories to the news media or elected officials.
Bureaucracy aside, the routine course of primary business poses many complexities reinsurers aren't used to, including billing, collecting premiums, issuing endorsements and policy changes, auditing, claims tracking, and reporting policy and financial statements to each state. All of this requires a well-developed infrastructure.
All direct insurers need automated systems that provide early evaluation and detection of problems. Otherwise, they can fail to capture key data and underprice risks. For instance, they may put small policies on the books as minimum-premium policies, but the real risk is much greater than that and the company remains in the dark until heavy losses start rolling in.
Reinsurers writing direct business need automated systems for communicating with and keeping close tabs on their MGAs - including making sure they are properly handling state regulatory reporting, if they've been assigned that duty. In a survey conducted last year, the American Association of Managing General Agencies (AAMGA) found there were 254 MGAs writing $10.9bn in premium from 438 offices across America. AAMGA believes the trend line is up due to the hardened market, plus the fact that traditional carriers are focusing on more-traditional, standard lines of business, leaving the specialty lines for the excess and surplus industry.
Reinsurers which have a large volume of permanent direct business can justify buying a comprehensive policy-management system that handles the insurance cycle from initial quote to underwriting, billing, auditing, claims and regulatory reporting. But many reinsurers have a smaller and more variable book of direct business. They face a conundrum: no reinsurer can afford to invest in a $10m system when it's writing $9m a year of direct business. Furthermore, its need may be temporary, and can change rapidly. Nevertheless, a reinsurer with even a moderate amount of direct business needs the capabilities of a powerful system to manage it properly.
It can make good sense for such a reinsurer to outsource some or all of its processing. The outsourcing vendor should understand the company's goals and serve its market in a manner that's consistent with the way it does business. By serving many different companies, credible vendors can achieve real economies of scale. It should provide the latest web-based technology and stay current with the minutiae of law and regulation in the 50 states and the District of Columbia. The vendor should be expert in processing direct business and all that goes with it, including communicating with MGAs. Today's web-based technology can give insurers control over business written through MGAs and ensure compliance with state regulations.
A reinsurer can convey its data to the outsourced systems provider via any form of input that's most cost effective. If the volume is substantial enough, communication should be electronic, either through the internet using file transfer protocol (FTP) or using a direct connection. The vendor also should be able to accept imaged documents. If the volume is low, the reinsurer can simply fax or mail paper to the vendor.
Deciding the best way to go takes much thought and planning. There are no simple rules to follow because there are a myriad of variables, including the lines of business, scale and scope of the business, and the expertise available in-house. Another important variable is the distribution model. If there's just one entity selling the product, a simple point-to-point dial-up system may be adequate. But if there are many sales agencies, a more complex technology infrastructure will be needed for interface. Here are some of the solutions reinsurers are using today:
Outsource everything. Sometimes it is most cost-effective to outsource virtually all processes. The vendor provides all the computer hardware and software, residing at its office. The MGAs use the system on the web, and to them, it's just like they're dealing with the company directly. The MGAs use the system for quoting, rating and billing. The outsourcing vendor enters required data, prints policies and handles compliance reporting, including monthly and annual financial statements (the so-called 'yellow books' required by the states and federal government). The vendor also provides the claims-management system, and, perhaps surprisingly, even the ceded reinsurance system. In addition, the vendor provides a data warehouse that accumulates data from the system so risks can be analysed as they are written. Reports can track new business by class code, state, exposure and coverage. This provides company managers with transparency so they can know what they're writing every day, avoid nasty surprises and take early corrective action if the risk profile doesn't fit expectations. With full outsourcing, the vendor's ongoing fees will be higher, but because the reinsurer doesn't have to buy and maintain any technology, it can be the most cost-effective solution for some companies;
Outsource only maintenance and/or regulatory reporting. At the other end of the spectrum, the company licenses primary policy-management software, runs it on its own hardware and does its own processing. However, it outsources maintaining rates, rules and forms - a time-consuming job that an outsourced vendor can do at lower cost. It may also want to outsource reporting to state DMVs, ISO, the National Council on Compensation Insurance (NCCI) and state workers' compensation bureaus. This is time-consuming 'grunt' work that a vendor can often handle better and more cheaply;
Outsource back-end functions while MGAs handle front-end functions. Here, the outsourcing vendor provides all back-end processing: claims, reinsurance analysis, billing, compliance data collection and financial reporting. This solution allows MGAs to use their own systems for the front-end functions of quoting, pricing and underwriting. The vendor takes the data feed from MGAs, processes it and provides reports to the insurer. The insurer might handle policy issuance and printing and provide the data warehouse. It may decide to handle regulatory reporting, using the data collected by the vendor.
Ultimately, all the choices boil down to cost-effectiveness. By carefully analysing choices, insurance executives - in partnership with the technology provider - can develop a strategy that will result in the most cost-effective model for managing direct business.
By Clyde Owen
Clyde Owen is Vice President of Outsourcing at Hartford, CT.-based Insurity Inc (www.Insurity.com), a provider of policy-management services to the property/casualty industry, including leading reinsurers. Email: firstname.lastname@example.org .