How Can a Small Company Manage Capital (and Grow)?
During my career, I’ve attended and participated in numerous sessions about small companies. One was titled “Are small companies going the way of the dinosaur?” Another had an implicit theme “Can small companies survive?” There may have been another one with a theme “Should small companies survive?” My basic answer to these types of questions is “Yes, they can survive, but, in vernacular, it ain’t easy.”
One question is just what constitutes a small company? The historic FIT threshold is $500 million assets. Today, $1 billion, Small Company Administrative Rescue Process even $2 billion, might qualify as a “small” dividing line.
Small companies seem pretty much a U.S. phenomenon. I know there are no small companies in Canada, and I’m not aware of similar companies in other countries.
From a 2005 National Association of Insurance Commissioners (NAIC) statistical summary, there are about 700 US companies out of 1022 with under $500 million assets. The great majority of these are under $100 million. Many of the 700 are affiliated, some are stagnant. Arguably, the ones trying to grow, who are concerned with capital management, carry at least $100 million assets today.
Marketing of products is essential to growth. However, since capital usually suffers initial adverse impact from marketing activity, the function is a two edged sword and must be managed very carefully.
It’s been stated before that a small company should seek marketing niches. “Don’t try to be all things to all agents” is often advised. This means that several, but not a great many, niches should be attempted. Preferably, they should be “safe” niches. Today, lines like long term care, stop loss, long term disability, and variable products are often considered unsafe for small companies, due to uncertain claims experience, claims volatility, start up expenses, specialized personnel required, or a combination of the above.
Small companies have often complained that rating agencies are biased against them, and focus entirely too much on size. In any event, in dealing with rating agencies, a company should avoid the above niches that are out of favor today. At the very least, it should not be deemed overly concentrated in any one of them.
Some companies have claimed that, if they receive a lowered rating, their marketing activities would cease, and they might as well close their doors. However, some small companies can be pointed to that have been able to sell significant new business with less than, say, an A- rating from Best. Since selling insurance is highly psychological, a company should decide whether its desired marketing niches will tolerate a relatively low rating.
In any event, a company should measure in advance how high a rating it needs to be successful, and how much a high rating would conflict with its other desired elements of management flexibility.
Some small companies rely heavily on reinsurance. Professional reinsurers can provide surplus relief and thus protect capital, as well as underwriting and related advice. However, reinsurance should not be considered a panacea. First, reinsurance prices seem to be rising today. Due to likely small volumes ceded, some reinsurers are reluctant to deal with small companies.
If a company intends to use reinsurance for a product, it should determine what amounts it would need for anticipated sales, how much reinsurance is available, and at what cost. Because of complex product designs, in terms of rate guarantees, recapture provisions, etc., reinsurance contracts should be read very carefully.
Of course, small companies that specialize in preneed or final expense products sell small size policies that often involve no reinsurance at all.
Modeling and risk management are frequently used terms today, and they are important to small companies.
An efficient, thoroughly tested model is essential in managing a company and its capital. The model must be understood, first by management as to its output, and by competent technical personnel as to its minute working details.