No matter how difficult or specialized the job, there is always someone who can do it, some company that exists solely to perform a function that exceeds the capabilities of its clients. Even in the insurance industry, which by its very nature demands the development and application of sophisticated and complex disciplines and products to perform one of the most difficult tasks – calculating the chances of possible calamity to life and property and placing a dollar value on the financial protection from such a calamity-there are certain areas of business that confound and confuse even the biggest and most established of players.
MetLife Auto & Home, a subsidiary of insurance giant Metropolitan Life, needed such expertise for writing commercial auto insurance for the residual market in the Commonwealth of Massachusetts. The company chose Pilgrim Insurance to do the job.
The Buyer Didn’t Possess the Know-How
“Residual market insurance is that class of business that companies don’t wish to write,” explains Vincent Nieroda, president of Pilgrim Insurance. “You might be a driver who has had 10 accidents. Most companies would not want to write you. If they did, they might charge you an extremely high premium. Each and every state has a residual market mechanism that guarantees you can get insurance for a semi-reasonable cost.” This mandate not only ensures that bad-risk drivers can obtain auto insurance, but it also protects them from having to pay exorbitantly high premiums.
Obviously, insurance companies write this business at a loss, and many don’t possess the know-how to handle it efficiently. Observes Nieroda, “They simply aren’t used to dealing with this class of business, with the frequency of accidents, with the special investigations.” MetLife is one of a growing number of insurance companies that recognizes it is ill equipped to effectively service such an unprofitable, albeit small, block of business. So it outsourced it to Pilgrim.
Massachusetts, like all other states, requires that insurers operating there provide automobile coverage for everyone, regardless of driving record. The Commonwealth Automobile Reinsurers (CAR) is a joint underwriting association that places undesirable risks in a pool. Consequently, all the companies doing business in the Commonwealth share the underwriting loss from that pool. Most states have residual markets between five and 10 percent of the total market; Massachusetts residual market stands at about 12 percent, down from a staggering 65 percent about five years ago. Currently, loses are at about $200 million per year, down from $500 million 19 years ago, according to CAR.
Bob Harvey, vice president and controller of MetLife Auto & Home, knew that when the Commonwealth of Massachusetts mandated a few years ago that insurance carriers had to provide dual service-personal and commercial auto insurance-MetLife would be out of its bailiwick writing commercial auto insurance. “What necessitated Met to outsource is that we’re a personalized company. We don’t write commercial auto-we have no expertise in it. Pricing the commercial lines as well as the underwriting, administration and the agency management would have been basically a diversion for us. We would have spent a lot of resources on something that was a very small piece of our business.”
If MetLife had to endure the pain of servicing the residual market, its executives wanted to dull it as much as possible. Pilgrim Life proved to be strong medicine.
Mitigating the Loss
Pilgrim Insurance Company is an insurance company that doesn’t really sell insurance. Instead, it supplies its clients with the necessary know-how to efficiently service a block of business that will not generate an underwriting profit. In other words, the company helps its clients lose less money. Says Pilgrim’s Nieroda, “Because it’s a mandated class of business that each company in the state has to write, everyone knows that they are going to lose money on it. When we were evaluating that 15 years ago, we decided that we could provide a cost-effective solution to allow our clients to not make money but actually lose less money by outsourcing this.”
Nieroda likens the underwriting loss associated with servicing the residual market to being a de facto tax levied against insurance carriers. He says that by defining a way to more effectively service residual business, both on a loss basis and a cost basis, Pilgrim can pass some of the savings on to the account and keep the rest as margin. According to Nieroda, when Pilgrim took over the residual market business from MetLife, MetLife was servicing about $4 million in premium volume). Pilgrim reviewed it and disqualified over 60 percent. Within 18 months, the amount of premium business MetLife serviced had been whittled down to about $1.5 million.
The relationship between Pilgrim Insurance and MetLife Auto & Home is pretty simple. MetLife picks up the claim risk, but Pilgrim handles all of the administration. Met pays Pilgrim a fee for the underwriting and all of the agency management and a percentage of the premiums. Policyholders in Massachusetts who are underwritten by Met receive Pilgrim Insurance policies. When they make a claim, it is with Pilgrim Insurance. As far as they are concerned, Pilgrim is their insurance company. For its part, Met reimburses Pilgrim for losses and services rendered.
As specialized as residual market insurance may seem, it is not outsourced as heavily as one might expect and, according to Vincent Nieroda, there’s only about four or five companies servicing this sector. However, he sees more insurers realizing the need to outsource residual market business. “The biggest misconception is insurance companies don’t understand the cost differential between this class and the regular class of business,” Nieroda says. “Traditional risk-bearing insurance companies have two things that they measure: loss ratio, which is dollars paid against premium earned; and expense ratio, which is dollars paid to run the operation versus the premiums.” Nieroda maintains that insurance companies usually impute the expense ratio to their entire book of business without differentiating between regular business and residual business.
Pilgrim and MetLife have a five-year agreement with a one-year option. MetLife is now in the option year, but MetLife’s Bob Harvey doesn’t foresee any change in the relationship. “My plans right now are to continue as long as the business is still there. Right now our plans are to continue the relationship indefinitely and just renew it on an as-needed basis.”
Lessons from the Outsourcing Journal:
- When government regulations require insurance companies to provide coverage that is beyond their expertise, outsourcing can solve the problem.
- When insurance companies have to provide coverage to unprofitable customers, an outsourcing service provider can help by taking over the process so the insurer loses less money.