Comment: How to Pick an Insurance Partner for Your Bank

Insurance is not a simple business. Underwriting, setting rate schedules, marketing, and handling claims can be tricky. Also, important skill sets differ by jurisdiction.

The best way to pick a partner is to pick one that has a track record of profitability and growth that exceeds industry norms.

Insurance is a cyclical industry. Some years can be very profitable; others will cause significant losses. These cycles are not just a function of judicial systems or catastrophic losses-there are other factors, which have never been fully explained.

Also, it harder for a growing company to be profitable than for an shrinking one. Therefore it is important to pick not just a profitable partner but one that can grow profitably.

It is also important to not be fooled by underwriting cycles. It's no great achievement, for example, for a company to have been profitable in personal auto insurance in California in the last five years; the business itself has been extremely profitable. Look for an insurer whose track record exceeds its peers'.

Insurers you consider should meet some threshold standard of financial strength. In underwriting a mortgage your bank generally will not accept an insurer with an A.M. Best rating below A-minus. This is a good standard to use as a start.

Even if it meets this standard, be certain you understand the insurer's financial strength, so there are no surprises. Three areas of concern should be investigated.

Loss reserves. Does the company have enough money set aside to pay claims on outstanding policies? If not, what is the shortfall and how is it being managed?

Environmental liability. Many insurers that wrote commercial liability coverage have found themselves liable for costs related to cleanup of polluted sites (especially those related to the Superfund) or illnesses linked to chemical exposure. These liabilities are huge and very difficult to quantify.

Reinsurance. This is a mechanism that an insurer uses to reduce its risk and exposure to loss. For a premium, reinsurers assume part of the risk.

There are two areas of concern here. One is the financial strength of the reinsurers. The second is catastrophe coverage-can the insurer survive a hurricane, earthquake, or even series of tornadoes and hailstorms?

Each policyholder presents different risks; insurers need to charge rates that reflect those risks. Rates should be based on loss experience and competitive information.

Rates for auto insurance should at a minimum reflect age, driving record, vehicles to be driven, garaging location, commuting distance, type of use, safety features, and the existence of prior insurance. They should also reflect, where this is legal, the applicant's marital status and sex.

Rates for homeowners insurance should include replacement cost, market value as a percentage of that cost, safety features, construction, availability of fire protection, and location, including such factors as likelihood of earthquake, hurricane, and brushfire.

Insurers should avoid issuing policies that cannot be properly rated or handled. For example, guidelines that prohibit the rating of youthful drivers are not appropriate, because rates can be established that make the risks profitable.

Another important issue is rating integrity-obtaining accurate information about an applicant so the proper rate can be quoted. This means asking the right questions and using outside data sources, such as motor vehicle reports, claim information, information about household members, and even credit report data.

Marketing is also important. Does an insurer know where its profitable niches are? (They change frequently.). The insurer should also have experience marketing to affinity groups. Your customers have an affinity with your bank; your insurance partner should respect it and use it.

Prompt, efficient, and expert claim handling can make or break an insurance program. If the claims people do not respect your customers and treat them well, you will face the backlash. Conversely, if the claims staff always pays whatever is asked, the losses will grow and the program will not be profitable. Local expertise is essential; customs and traditions differ dramatically.

Insurers need to understand market and regulatory differences. For example, Ohio and Michigan have similar demographics but very different insurance markets. Michigan has a no-fault law with very high medical and work-loss benefits and severe restrictions on lawsuits. Ohio has no special medical or work-loss benefits but permits lawsuits in without restriction.

On the regulatory front, local knowledge is especially important. For example, obtaining approval of a personal auto rate filing in New York is not difficult, but may take as long as a year-and filings are generally not approved more often than once a year. In Florida, by contrast, insurers may implement rate changes before even filing them with regulators (who nevertheless strongly discourage the practice).

Such local knowledge that is important for an insurer operating in your market.

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