Major Problems Ahead

One proposed anti-steering regulation reads, in part, "If the producer represents multiple insurers, the producer must either forward to the client a proposal from each available insurer, or select the proposals to be forwarded to the client based solely on objective criteria supplied by the client or disclosed in writing to the client."

Such proposals present significant problems for customers, agencies, and companies. One such problem is that very few consumers adequately understand the details of insurance company financial stability, coverages, and claims service. They understand the importance of these issues in general, but not the details because the complexity is simply huge. Even some people within the industry struggle to understand all the details. (Just think about how many people are upset at the rating companies for not pulling ratings quickly enough on several now defunct insurers!) However, agents do generally have a significantly better understanding of these issues than consumers and they typically try to combine the best price with the best of those other factors.

These other factors, however important, are much less tangible than price, which makes price the primary focus point for consumers. Every agent has probably seen the situation where a weak company undercuts a stable company’s price and no matter how the agent explains the importance of choosing a strong company, the money talks.

If rules like the one above are enacted, I believe price will take on an even more commanding role. As a result, I predict, if passed, a temporary drop in prices because agents will be less able to steer clients to the stronger companies, the companies with the better claims service, and the companies that generally provide better products. A sale based on anything but price will get tougher.

Which companies usually lead the soft market? The weak companies! So who will benefit? The weak companies! The problems caused by weak companies will be exacerbated by these regulations. Just think about who had the lowest prices before Reliance went out of business. Think about which companies often have the lowest prices.

These regulations mean considerable additional E&O exposures because if more clients are placed with weaker companies, agencies face the potential of having more clients not getting their claims paid. It becomes imperative that agencies implement tracking systems to notify clients of downgrades when they occur, not just at renewal. It becomes imperative agents specify the difference in company ratings and consider more than just one rating company’s rating. And at times, it requires agencies advise clients that based on a company’s stability, you do not recommend the client go with that company, regardless of the price.

Under these regulations, when a company goes out of business agencies are more likely to have larger books with weak companies than they otherwise would. Therefore, agencies also run a significant reputation risk. Agencies must prepare in advance to protect their reputation in these situations.

Obviously too, in addition to higher costs due to having to prepare more quotes, customers being placed with weaker companies, higher E&O exposures, and higher reputation risk, agency revenues will probably decrease too, but not because the customers are getting better deals. The customer’s premium may be lower, but considering the extra risks of the better price, their total cost will probably increase and at the same time, lower rates means lower commissions for agencies.

In addition to generally lower rates, retention may decrease too because greater focus on price means less loyalty to an agency. Also, brokers and large agencies are often compensated better than regular agencies and at times, they can also obtain lower prices for clients. Since price will become an even larger deciding factor than it already is, this logic suggests clients will migrate to the larger agencies and brokers, possibly to some of the same entities that caused these problems initially!

Strong insurance companies will suffer too. They will be forced to process more quotes. Companies are not staffed to do this. Many will also have to modify their business plans if the plans are based on only quoting business they have a very good chance of writing, which is efficient and economical. To do otherwise introduces considerable waste. At the same time, prices will be pressured by weak companies seeking survival.

Companies will also see the bigger agencies and brokers grow stronger which really is the genesis of this entire scandal. Some brokers got big enough to dictate terms to companies and this proposal would only make the situation worse.

I understand this regulator’s proposal and his good intentions. However, this regulation, like most of the others recently proposed, have significant and negative unintended consequences. I have no doubt new regulations and laws will be passed and I sincerely hope the people involved thoroughly think through the potential unintended consequences of their proposals before enacting them as permanent regulations or laws.

Insurance Coverage Alone Does Not Guarantee Complete Protection
By Michael Childress

In early July of 2001, George Richter, president of leading U.S. meat producer, Farmland Foods Inc., was in the midst of leading his company in the expansion and renovation of its 650,000 square-foot processing facility in Albert Lea, Minn. Company progress at the time was very strong and the upgrade of the massive plant was expected to propel Farmland toward even greater growth.

The facility, built in 1912, served as a production center for bacon and ham – two products that accounted for 62 percent of Farmland’s annual revenue. Under Richter’s guidance, it would soon replace the company’s Carroll, Iowa, plant and become Farmland’s headquarters for the two products, producing more than five million pounds of meat each week. On July 8, 2001, however, with the expansion project 50 percent completed, Richter received the devastating news that a fire, inadvertently ignited by one of the contractors working on the expansion project, had consumed the Albert Lea facility.

"We had already invested so much capital in the Albert Lea plant upgrades, and all of that was lost," said Richter. "Additionally, bacon and ham are our company’s two highest margin products, and the fire cost us 30 percent of our production and a significant opportunity to capture additional market share. Still, we were very fortunate that none of our 550 plant employees or any of the contractors lost their lives."

Farmland had protected itself against such a disaster with a comprehensive, $500 million "all risk" insurance policy on its plants, including the Albert Lea facility. What it would quickly discover, however, is that insurance alone does not guarantee complete protection.

Preserving Insurance Benefits
Immediately following the fire, Farmland intended to take whatever steps were necessary to restore the Albert Lea facility and reopen it for business.

At the time of the fire, the company was leasing the property with an option to buy. Farmland’s landlord, acting in what it perceived to be its own best interests, moved to terminate the lease and trigger the option, thereby nullifying the company’s ability to recover rental payment insurance benefits and leaving Farmland as the owner of a distressed property.

Farmland retained a law firm to create a solution that worked for the landlord, while at the same time, preserved Farmland’s insurance policy benefits. Attorneys were able to meet with Farmland’s landlord the week after the fire and strike a deal whereby it would continue the company’s lease on the property, thus preserving Farmland’s insurance benefits.

Surveying the Damage
The law firm coordinated all cleanup activities for the Albert Lea facility, taking special care to ensure that pertinent evidence was preserved and documented. The firm also called in outside experts in the fields of structural engineering, food safety and mycology to inspect the remains of the plant and determine the feasibility of restoring it to working condition. After a tour of the facility, however, it quickly became clear that reopening the meat processing plant – in light of both Farmland and the USDA’s stringent standards for food safety – would be impossible.

"When we inspected the Albert Lea facility, we found severe structural, smoke, and water damage," said Richter. "Additionally, we found that nearly one million pounds of meat in various stages of processing had been ruined. The structural damage made it impossible to get inside some sections of the facility for weeks to remove much of the ruined meat. Obviously, that much spoiled meat sitting in an open area during a hot, humid summer presented huge problems in terms of contamination."

In fact, this contamination became Farmland’s biggest challenge. Ankle-high standing water, a byproduct of the firefighter’s use of nearly 3 million gallons of water to combat the fire, combined with the spoiled meat and summer weather, provided an ideal breeding and feeding ground for fungi, rats, flies and maggots. Additionally, the city of Albert Lea’s sewer system was unable to handle the massive amounts of water and debris that the fire produced; the city ordered Farmland to plug its sewers and drains to prevent additional drainage from the facility. This turned the plant and its property into a virtual cesspool of contamination as raw sewage, animal fats, animal blood, ammonia used for meat refrigeration, and bacteria seeped into the soil.

After touring the Albert Lea facility and consulting with experts, it was determined that although the fire had destroyed only 30 percent of the structure, the building was a "total loss" in terms of future usability. Under the city of Albert Lea’s order, it would have to be condemned and demolished. Any food processing plant must comply with USDA standards in terms of cleanliness and safety, and the fire had exposed even areas that were not burned to long-term contamination.

Arguing a ‘Total Loss’
Acting on the advice of its experts who had deemed the Albert Lea plant a total loss, the law firm coordinated Farmland’s insurance claim presentation, seeking $125.1 million for the replacement of the Albert Lea facility, destroyed equipment, post-fire emergency building repairs and stabilization, and continuing rent on the property. The most compelling fact supporting Farmland’s claim was the now empty lot on which the demolished facility had once sat.

Farmland’s insurers, however, saw things differently, arguing that since only 30 percent of the facility had been damaged by the blaze, it was not a total loss and could have been reasonably repaired rather than being demolished. Ultimately, they used this argument to refuse Farmland’s claim, largely ignoring the fact that the city of Albert Lea, not Farmland, had ordered the plant razed.

In situations like Farmland’s, the insurance companies almost always have the upper hand. Most policyholders leave it to the insurer to determine how much of a claim should be paid in the event of a loss. In the event of a dispute, the insurer again has all of the power, with vast experience in insurance litigation and unlimited access to the expertise and resources necessary to successfully litigate any claim.

In the Farmland Foods matter, the company’s decision immediately following the fire to retain the services of a law firm that helped level the playing field between Farmland and its insurers.

In the absence of experienced legal counsel, Farmland might have been forced to accept the position of its insurers. Instead, it was able to challenge them to an eventual stalemate. On the verge of bringing the matter to litigation, Farmland and its insurers agreed to participate in a two-day mediation.

Negotiating a Settlement
During mediation in San Francisco, Farmland’s position was that it would be unreasonable to expect the company to risk the health of its valued consumers, as well as the civil, criminal, and business liabilities potentially associated with the production of adulterated meat by a "repaired" facility. Following a lengthy session, a settlement of Farmland’s claim on the Albert Lea facility was reached for a total of $63 million, well above the $28 millions that insurers had originally offered.

The settlement was ultimately fair to both parties. Most importantly, it enabled Farmland to move on from this disaster and focus on resuming normal operations. Additionally, it enabled the insurers to avoid a the potential risk of losing this matter in a courtroom setting.

Proactive Disaster Planning a Necessity
While the law firm ultimately succeeded in helping Farmland garner an equitable insurance settlement, the situation brings into clear focus the need for companies to proactively protect themselves against potential disaster situations.

Once an unforeseen incident occurs, it is often too late to think of all of the details that a comprehensive loss management program would have covered. In Farmland’s case, with the law firm retained after the fire, attorneys had to quickly obtain copies of all nine of its insurance policies and lease agreements, evaluate them, and formulate the best possible client solution. Had the firm been working with Farmland prior to the incident, all appropriate documents would have been on file and subjected to a pre-loss policy analysis that identifies potential areas of exposure and ensures that a policyholder receives maximum coverage in the event of a crisis.

Having a loss management program in place prior to the fire would have also enabled attorneys to take a more aggressive position with Farmland’s insurance providers and guide the company through the claims process much more rapidly.

Attorneys would have also been able to sit down with Farmland’s insurers prior to the disaster occurring. It is very likely this matter would have been resolved in far less than the two years it ultimately took. In fact, with the law firm and insurance companies working together from day one, Farmland’s case would have likely never headed down the path toward litigation. A simple pre-loss communication between all parties would have made for a much more amicable resolution.

Michael Childress is a founding shareholder of the law firm of Childress Duffy Goldblatt Ltd. and leads the firm’s loss management group. His expertise encompasses the fields of insurance coverage, business litigation involving shareholder rights, commercial losses, and real estate transactions. Childress received his bachelor’s degree from Marquette University in Milwaukee in 1977, and his Juris Doctor from Chicago’s John Marshall Law School in 1981. He is also a member of the Chicago Bar Association, the Illinois State Bar Association, and the American Trial Lawyers Association.

©Copyright 2004 Systems Support Inc. All rights reserved.

Reprinted with permission from the Disaster Recovery Journal, Winter 2005, p. 28-30, www.DRJ.com.   Further reproduction is prohibited.

Desire to Maximize Profits?
Build Trust

A 2001 study cited by The Economist (November 10, 2001, p. 75) noted that sellers on eBay with high trustworthiness scores sold coins for 6.8% more than lower rated sellers. Trust can also be valuable for insurance agencies. The more customers trust a producer, the easier it is to close sales and less time is required for each sale, leaving more time for making sales. The more trust CSRs have for a producer, the harder they work for the producer. The more trust companies have in a producer, the more leeway the producer is given. Trust results in profits.

Trust, though, is a double-edged sword. On the good side (for salespeople), trustworthy people find it easier to separate people from their money. Trustworthiness then is a significant competitive advantage. In fact, trustworthiness is the key competitive advantage possessed, in my opinion, by many producers. They are so good at making people trust them that they do not always need many other skills to succeed. I am sure you all know–or maybe you are one–a producer who never has to solicit business, it all just flows to him or her and it comes in huge amounts. This is where the other side of the sword comes in. If a producer can easily sell his or her personality, why develop better producers and services? Why go overboard? Why oversell?

This is an economical and thrifty selling philosophy and I agree with it, when this philosophy is enough. More and more though, it is not enough, especially given the loss of credibility our industry has suffered lately. We have to establish trust by providing tangible evidence, not just a sunny personality. Tangible proof is even more important if an agency is developing young producers. These young people are still developing their style, their confidence, and their ability. Additionally, selling insurance as a young person is difficult because insurance is sold peer-to-peer by age group. Not too many 27-year-old CFO’s exist so 27-year-old insurance peddlers have a harder time selling to a 55-year-old CFO. They need more to back them. They need to be able to sell the agency, not just themselves.

Examples of tangible trustworthiness include:

• Ensuring everyone in sales and support has a professional designation (or does within three years of being hired).
• Writing, or at least offering, the correct coverages by using a coverage checklist (I have actually tested this as an example of trustworthiness and it scores very high).
• Making professional presentations. Too many agencies are still using poorly designed black and white proposals. This is the 21^st Century. Using color is cheap and easy.
• Clearly communicating who is compensating you (by the company or the client or both, though not necessarily how much you are compensated by the company--and be sure to consult your attorney first) and a mission statement applicable to individual clients. I use to not believe in mission statements, thinking they were mostly fluff (and I still think this is true for corporate mission statements). A mission statement or commitment to individual clients though is very different and very important.
• Use the Total Cost of Risk (TCOR) approach developed by Rob Ekern, of C.R. Ekern & Company (see www.crekern.com for more information).

Some people are blessed with a natural trustworthiness, but many opportunities exist to build tangible trust that can benefit every agency. I find it interesting that in the eBay study, trust was worth a 6.8% higher sales price. 6.8% is almost identical to the average agency profit margin. How would you like to double your profit? Trust is valuable!

NOTE:  The information provided in this newsletter is intended for educational and informational purposes only and it represents only the views of the authors.  It is not a recommendation that a particular course of action be followed.  Burand & Associates, LLC and Chris Burand assume, and will have, no responsibility for liability or damage which may result from the use of any of this information.

Burand & Associates, LLC is an advocate of agencies which constructively manage and improve their contingency contracts by learning how to negotiate and use their contingency contracts more effectively.  We maintain that agents can achieve considerably better results without ever taking actions that are detrimental or disadvantageous to the insureds.  We have never and would not ever recommend an agent or agency implement a policy or otherwise advocate increasing its contingency income ahead of the insureds’ interests.

A complete understanding of the subjects covered in this newsletter may require broader and additional knowledge beyond the information presented.  None of the materials in this newsletter should be construed as offering legal advice, and the specific advice of legal counsel is recommended before acting on any matter discussed in this newsletter.  Regulated individuals/entities should also ensure that they comply with all applicable laws, rules, and regulations. 

If you wish to be removed from this mailing, please e-mail AgencyAdviser@burand-associates.com.
Copyright 2005, Chris Burand