Finding value in size: fueled by an underwriting-profit culture and focused on niche markets such as motorcycle coverage, Pacific Specialty Insurance Co. competes with industry leaders. (Market Competition: The Big Picture).

Being more nimble is one of several advantages Pacific Specialty Insurance Co. sees in its size.

Being a small carrier certainly hasn't stopped the Menlo Park, Calif.-based company from growing its business to a projected $120 million in premium this year from $5 million in premium just a decade ago.

"The advantage of our size allows us to quickly take advantage of market conditions," said President and Chief Executive Officer Michael J. McGraw, whose father created the company in 1988. Pacific Specialty; the flagship of the McGraw Group of Affiliated Cos., was licensed on Dec. 28, 1989, and began writing business on Jan. 1, 1990.

In 1976, McGraw's father, Jack, founded McGraw Insurance Services, a specialty general agent, surplus-lines broker and Lloyd's correspondent. Before that, he was president of El Dorado Insurance Co. in Palo Alto, Calif.

Pacific Specialty now writes about 90% of its direct premium in California. Its personal-lines products include property, motorcycle, marine, automobile and personal liability, while commercial products, which account for about 5% of the company's total premiums, consist of used-car dealerships, beauty/barber shops and business owners coverage for landscapers and janitorial services.

In 1994, the Northridge earthquake in California sparked the company's decision to move into the homeowners market. One year later, it began selling auto insurance on the heels of new legislation in California that McGraw said "put a little teeth into mandatory auto law." The law mandates that residents include proof of insurance when renewing their auto registrations.

In addition to being more nimble, the company is better able to understand the markets it serves because of its small size, McGraw believes. Two of its popular product lines--motorcycle and personal-watercraft insurance--have been very successful for the company over the past several years. During the 1970s, Jack McGraw, known as a pioneer of motorcycle insurance, recognized the role that motorcycle dealers played in reaching customers, and he eventually changed the company's distribution channel to include dealerships. Today, Pacific Specialty's insurance is sold through more than 300 motorcycle dealers. The company produces much of its personal watercraft sales from the same dealers, who in most cases sell both motorcycles and personal watercraft.

Pacific Specialty is among the pioneers of model rating for motorcycle coverage, in which insurance is rated based on the make and model of the vehicle. The company later implemented a similar rating approach into its various property products. "For example, rather than looking at the age of a home, we look at other factors, such as whether or not the home has galvanized pipes vs. copper pipes, and the age of the roof," said McGraw.

Underwriting Profit 

The company is committed to achieving an underwriting profit and has reached this goal every year since its inception. "Another advantage of our size is the ability to look at a $5 million program and think, 'If I can make a 10% underwriting profit, that's $500,000 and that's good money,' while a larger company won't even consider a $5 million program," said McGraw, adding that the company falls into a size category that doesn't have any minimum thresholds as to how much premium a product must make. "In fact, a number of our products are written at less than $5 million in annual premium," he added.

The success of the company also can be seen in its numbers. "It's been a great success story-we've grown from $3.1 million in GAAP surplus in 1990 to about $65 million today," said McGraw. In addition, the company said its direct premiums exceed $100 million and total assets are more than $142 million, with $56 million of policyholders surplus. Pacific Specialty's five-year average combined ratio is 84.1.

The company believes its dedicated interest in underwriting profit makes it somewhat unusual in the industry. "The executives that run the company don't have any compensation or objectives based on either premium volume or investment income," said McGraw. Pacific Specialty outsources all of its investment management to professional money managers, and it is managed internally by the company's chairman, Jack McGraw "We only concentrate on producing an underwriting profit, and if we can do that with $150 million in premium, then that's what we'll write; if we can do that with $50 million in premium, then we'll write that, too," Michael McGraw said.

He also said the company isn't concerned about big swings in premiums, which is evidenced in its data. "Post-Northridge and on the heels of the homeowners crisis and the new California auto law, we wrote a ton of premium and then suffered a downswing of about 30% premium for two to three years," he said. "You have to be able to contract when the market really won't allow you to make an underwriting profit."

In addition, McGraw said the company is positioned to capitalize on the current hard market. "We have products we have designed and put out in states that haven't written any premium for two to three years during the soft market, and when the market turns and pricing comes back to us, we're then in the position to take advantage of that," he said.

He also said the company has appropriate policy contract terms. "We've always had adequate policy language that excluded what was appropriate to be excluded," said McGraw, adding that when a hard market emerges, the industry comes to the company. "But when there's a soft market and competitors give coverage away and price inadequately, then the market leaves us," he said.

In competing against larger players m the same market, McGraw said good service is key. "For alternative distribution systems, company size doesn't tend to matter, and independent agents are now also beginning to realize that customers are relying more on their judgment than on a company's size," he said. Pacific Specialty currently has more than 10,000 independent agents, serving all 50 states and the District of Columbia.

Under the Influence

Technology has also played a huge role in the company's success. As one of only two insurers located in the heart of the Silicon Valley, Pacific Specialty has had an especially strong exposure to the information-technology arena. "Virtually all of our executives in some aspect of their personal lives know someone in the technology business, and this helps us be very tech-savvy because we live in the very heart of the technology area," said McGraw. However, he said the advantage hasn't been so much in terms of what the company should do but more in showing it what not to do.

"We tend to be able to distinguish between what's hype and what's reality. This area offers us the unique perspective in terms of operating our company, because we can't attract our employees here by comparing them to what kind of job they can get with other insurers, but rather we have to make the comparison to technology companies," McGraw said. Because of that, he said Pacific Specialty's employee salaries tend to be somewhat higher than the industry norm, and because of their personal exposure to the technology super-subculture, "our people technologically don't think like insurance company executives but more like high-tech company executives."

Despite its small size, Pacific Specialty relies very little on shared industry resources, particularly for product development and rate making. The company almost exclusively manuscripts its own policy language, said McGraw. "And because the industry is generally losing between five and 15 cents on every dollar in underwriting profit, and since we have committed to always making an underwriting profit, we don't rely too heavily on what else is going on in the industry and shared industry resources," he said.

Looking forward, McGraw said he expects the company to continue growing as long as the market remains hard. "Inevitably, we'll see a contraction for us, perhaps a potentially significant contraction in terms of premium as the market softens, but we're prepared for that," he said. While continued growth of premium isn't in the company's game plan, maintaining an underwriting profit and serving its more than 250,000 policyholders remain the focus.

RELATED ARTICLE: Pacific Specialty Insurance Co.

* Headquarters: Menlo Park, Calif.

* President and Chief Executive Officer: Michael J. McGraw

* Products: Personal lines: property, motorcycle, marine, automobile and personal liability. Commercial products: used car-dealerships, beauty/barber shops and business owners policies

* Licensed: All 50 states and the District of Columbia

* Principal Reinsurers: Odyssey Reinsurance Corp. and Toa Reinsurance Company of America

* Incorporation: Under the laws of California on April 18, 1988. Licensed on Dec. 28, 1989, and began business Jan. 1, 1990

* Financials (2002): Net premiums

written--$98 million; direct premiums

written--$102.5 million; pretax operating income--$3.3 million

* Web site: www.mcgrawgroup.com