Property Casualty Market’s Love Affair With Main Street Business

Why Small Business Means Big Business for Insurers and Brokers Alike

Main Street business often means different things to different people, but it generally refers to small commercial establishments that would be found in towns and villages across the United States. The Small Business Administration (SBA) is a federal agency devoted to this commercial market as “the voice of small business in government.” The SBA defines small business as one with fewer than 500 employees and includes more than 6 million small employers and 21.7 million non-employers (i.e., self-employed). They represent a formidable group:

• Employ more than half of the U.S. private sector workforce;
• Hire 40 percent of high-tech workers including, scientists, engineers and computer workers;
• Include 52 percent of home-based businesses; and
• Represent 99.7 percent of all employer firms.

In respect to historic job creation, small business has been the driving force in our economy (see “Net Job Change by Size” chart).

This chart’s data provides a brief overview of the aggregate size of this small commercial market segment that has long been the focus of local and regional insurance carrier markets, both direct writers and agency companies.

The insurance market definition of small commercial accounts is usually expressed somewhat differently than on employee count — account premium size appears to be the preferred method. For example, a small, commercial account might be any account developing $25,000 or less in annual premium for all property/casualty coverages combined.

National insurers such as The Hartford, Travelers, Zurich and others traditionally have not done well in this market segment as their marketing and technical underwriting resources were heavily focused on the larger firms, including national and global companies. However, they became much more aggressive following the insurance market crises of 1985 in exploring ways to penetrate this small business segment.

Market Crises Changes Strategy

The market crisis of 1985 was the turning point that set national insurers on the path to aggressively penetrate the small, commercial market segment. The early 1980s was a period known as “cash flow underwriting” marked by high interest rates. Underwriters suppressed liability insurance rates to gain cash for investment.

When interest rates declined rapidly, the crises that followed saw capacity disappear and policy rates escalate such that insurance became unavailable or unaffordable for many business firms. The aftermath of this collapse of insurance availability moved many global and national business firms to turn away from their traditional insurers to move into what has become known as the “Alternative Risk Transfer” market, including captives, risk retention groups and self-retention programs.

As market capacity returned to the traditional insurance market, many of these large, commercial insurance policyholders did not. Thereafter, at every point in subsequent “hard market” cycles, more of these large organizations would move parts of their risk financing premiums to these new ART facilities. From a market share of 12 percent in 1987, it grew to 32 percent by 2007.

National insurers saw the need to penetrate the small, commercial business segment as a way to replace commercial premiums now going to the ART market. It seemed that this market did not have many of the unfavorable characteristics now existent in most of the larger, commercial accounts. Small commercial organizations:

• Looked primarily to insurance products to cover their basic risk exposures;
• Had limited resources to view “alternative risk finance” solutions as practical;
• Basic exposures were homogeneous by classification and without the complexity in larger diversified risks; and
• Most coverage products could be packaged into a single transaction for marketing purposes.

Because underwriter’s technical resources in underwriting, loss prevention and claims handling were organized around the needs of the larger and more complex risks, they were, for the most part, extra cost baggage for writing Main Street risks.

So if national insurers were going to challenge local and regional markets for this business and still be profitable, they would need to build a different set of resources. Some decided to focus on a few industry segments regardless of size, while others pursued “program” business via trade association endorsement.

Regardless of the chosen platform, a significant investment in resources more adaptable to the needs of small business clients and the agents and brokers that produce that business were needed.

Taking Stock of Main Street Small Business Insurance Needs

National insurers who wanted to be successful in the Main Street market had to better understand what would make them successful in this market.

A major issue for these national insurers was the lack of any small account product emphasis and marketing effort, poor policy delivery timelines, and nonexistent distribution system focus. According to a survey by the Small Business Administration, small business owners are known to get advice from several sources, including: individual mentors (52 percent), social networks (51 percent), trade associations (44 percent) and business advisors (35 percent) as being among the most frequent sources. This meant that national insurers had to work cooperatively with their local agents in product design and service delivery to be successful.

Due to the size of the transaction in terms of commission revenue, these producers were seeking insurance markets that could provide efficient means of quoting, underwriting and policy issuance. This necessitated a seamless, integrated computerized system that wasn’t practical or feasible for the larger more complex commercial risks but now needed to penetrate small commercial business effectively.

So these national carriers decided to build a small commercial account capability that would give them a competitive edge in the market. These carriers:

• Identified risk classifications and territories that would offer them the best chance to build a profitable book of business;
• Created a marketing package of coverage that gave the appearance of customization;
• Built a computerized underwriting, quotation and policy delivery system to speed the delivery process;
• Organized agent and broker compensation systems targeted to this business to reward business production and created separate contingent commission agreements;
• Created “service centers” and invested millions of dollars in communications and systems technology to service the ongoing business needs of the policyholder acting as an extension of the agent’s service team. This usually required the agent to take a reduced direct commission reflecting the transfer of service responsibilities, but required the carrier to have personnel duly licensed as such.

This new capability in small commercial business also opened another opportunity. National carriers had long-standing relationships with national broker organizations and while most of these brokers had operations throughout the United States, some imposed production restrictions on commercial business unless they were of a certain size in terms of commission income. The rationale was that the cost of handling that business given their resources and overhead (i.e., focused on servicing large accounts) was not cost-effective. But given the national carriers’ new business model for small, commercial accounts, many of the larger brokers could now undertake the business profitably.

Today’s Main Street Businesses

The small commercial risk segment is very much a target of most insurance carriers for the reasons mentioned earlier.

The two major national carriers in this space are Travelers and The Hartford and their financial reports show a substantial commitment in terms of written business based on the charts below.

Whether Main Street business is called small commercial, selected accounts or referred to as community account business, it is a significant portion of the portfolio of these two carriers who collectively write $5 billion in annual premiums for this segment.

Although most insurers do not breakdown their underwriting profit sufficiently to isolate small commercial, the Hartford for the third quarter 2009 indicated a current year 86 combined ratio for that segment compared to 102.6 and 97 for the other two segments.

On the intermediary side of the business, the acquisition of agents and brokers by banking institutions was as much about cementing relationships with local business organizations as it was expanding the revenue base and product relationship. Banks had long been local community relationship-driven organizations — that was the driving force when Wells Fargo acquired Acordia, a privately held community market broker with a national distribution system in place.

Even mega-broker Marsh recognized a missed opportunity as it launched Marsh and McLennan Agency LLC with a $50 million war chest to acquire brokers with books of business below the national and global account status. They realize that success in these new segments means “re-inventing oneself,” which most often requires starting a separately focused organization directed and aligned with client needs.

Although the small, commercial segment comprises millions of firms and in 2008 grew by 627,200 businesses, it is prone to significant mortality with 595,600 closures and 44,000 bankruptcies, according to SBA. Seven out of 10 new employer firms survive at least two years, and about half at least five years. In 2009, it is expected the economy caused very few new firms and a drastic number of closures.

Main Street business, long known as small commercial, is still big business to insurers and intermediaries. Generally, this segment is more stable than others as this segment relies more heavily on the insurance industry then other market segments for risk transfer.

Topics USA Carriers Agencies Underwriting Property Market Casualty