How to build a recovery: one company's successful financial turnaround shows that procedures in all aspects of operations have to be adjusted to make corporate collection efforts work.Key Points * Underwriting Underwriting 1. The process by which investment bankers raise investment capital from investors on behalf of corporations and governments that are issuing securities (both equity and debt). 2. The process of issuing insurance policies. , reinsurance The contract made between an insurance company and a third party to protect the insurance company from losses. The contract provides for the third party to pay for the loss sustained by the insurance company when the company makes a payment on the original contract. , billing and collections, audit, legal, accounting and claims all affect collections. * A specific date should be set to differentiate run-off business from start-anew business. * Performance measurement tools must be used in all areas to motivate people and focus them on activities that drive the desired financial outcomes. As of Dec. 31, 1988, the known state of the national account book of business in a major U.S. property/casualty insurance company was as follows: * Combined ratio--114 and increasing, * Cash flow--negative, * Collection rate--unknown, * Billable receivables--unknown, * Overdue--$20 million and increasing, and * Schedule F penalty--$25 million and increasing. Later analysis would determine the situation to be more dire. Managers determined that once the problems began to arise, they were seeing only the tip of the iceberg tip of the iceberg n. pl. tips of the iceberg A small evident part or aspect of something largely hidden: afraid that these few reported cases of the disease might only be the tip of the iceberg. . The national account business portfolio also was replete re·plete adj. 1. Abundantly supplied; abounding: a stream replete with trout; an apartment replete with Empire furniture. 2. Filled to satiation; gorged. 3. with loss sensitive programs and alternative risk transfer mechanisms, including self-insured retention programs, deductible That which may be taken away or subtracted. In taxation, an item that may be subtracted from gross income or adjusted gross income in determining taxable income (e.g., interest expenses, charitable contributions, certain taxes). programs, captive programs, paid loss retrospective programs, incurred loss retrospective programs, banking excess plans and fronting programs. In April 1989, the chief executive officer, chief financial officer and chief underwriting officer established the financial services The examples and perspective in this article or section may not represent a worldwide view of the subject. Please [ improve this article] or discuss the issue on the talk page. department. Its mission was to immediately stop the bleeding, identify and rectify rec·ti·fy v. 1. To set right; correct. 2. To refine or purify, especially by distillation. areas that were creating the substandard substandard, adj below an acceptable level of performance. results, and set the company on a profitable course. To that end, the new department was empowered to make whatever changes necessary and was given significant influence over all aspects of the operations. In just two years, the Years, The the seven decades of Eleanor Pargiter’s life. [Br. Lit.: Benét, 1109] See : Time financial services department had begun to reverse the downward trend, as follows: * Combined ratio--104 and declining, * Cash flow--positive, * Collection rate--97%, * Billable receivables--100% identified (previously unknown receivables identified and collected totaling $100 million), * Overdue--$300,000 and stable, and * Schedule F penalty--$500,000 and stable. These results continued to improve over the next four years. All of these results were achieved without a significant investment from the company or using outside consultants and collection agencies. The following shows how this was accomplished and the lessons learned. Lessons Learned Lesson 1. Recognize that all aspects of the operations impact collections. This includes underwriting, reinsurance, billing and collections, audit, legal, accounting and claims. It became clear to management that a knowledgeable central force would be needed to coordinate the efforts of these areas. The processes in each area needed to be adjusted and improved so that they complemented other areas and supported corporate collection efforts. This was critical to success. Lesson 2. Resist the urge to mark off all open balances and unilaterally u·ni·lat·er·al adj. 1. Of, on, relating to, involving, or affecting only one side: "a unilateral advantage in defense" New Republic. 2. close out prior business written in an effort to "start anew a·new adv. 1. Once more; again. 2. In a new and different way, form, or manner. [Middle English : a, of (from Old English of; see of) + new ." This push usually comes from the underwriting and accounting areas in an effort not to be held accountable for this business and to reduce expenses. The actual effect is to worsen wors·en tr. & intr.v. wors·ened, wors·en·ing, wors·ens To make or become worse. worsen Verb to make or become worse worsening adjn the company's cash flow. Current and future receivables will be rendered uncollectible. Instead, set a date after which new and renewal business written is the "start-anew" business and needs to be handled properly. All business written prior to that date is "run-off" and needs to be reconciled and collected. Lesson 3. Educate people in all aspects of the operations on the program types being written. All areas need to understand their role in making the business profitable. They need to understand the consequences of not following procedures and guidelines guidelines, n.pl a set of standards, criteria, or specifications to be used or followed in the performance of certain tasks. . And this training needs to occur on a regular basis, not just once. Lesson 4. Use performance measurement tools in all areas of the operations to motivate people and focus them on the activities that drive the financial outcomes the company desires. To properly affect corporate outcomes, the development and performance objectives need to be identified and adhered to for each area of the operations. But make sure you use the correct measures or you may not get the results you desire. For example, the collections unit was using as a performance measure overdue ratio (overdue dollars/outstanding dollars), thinking this would motivate staff to reduce overdues in order to meet the ratio target. Rather, the outcome was that staff was delaying in collecting amounts due thereby increasing the outstanding dollars and getting a lower ratio. The financial services department fixed this by scrapping that measure and implementing two new measures, overdues (dollar target) and collection ratio (dollars collected/total dollars due). This identified departmental training needs that, when addressed, achieved the desired results. Lesson 5. Learn from the mistakes of the past. Operations Areas Step by Step The following issues were identified and addressed in some of the operational areas in order to reconcile the run-off business and handle the start-anew business properly. Underwriting * Be careful in depressing premiums when writing business. This can result in artificially low results regarding program and policy aggregates, maximum premiums, escrow/working funds and collateral amounts, as well as incorrect accounting ledgers. All of these outcomes will lead to bad underwriting results, poor cash flow and low collection rates. This was a serious situation that needed to be corrected and handled properly going forward. * When business is bound, communicate clearly and timely to all operating areas impacted by the terms of the deal, including accounting, billing and collections, claims and reinsurance. Have a standardized standardized pertaining to data that have been submitted to standardization procedures. standardized morbidity rate see morbidity rate. standardized mortality rate see mortality rate. reporting format so that the reporting for each deal is the same. Without this, confusion will reign and your results will suffer. * Be selective regarding the form of collateral you accept. The form of collateral preferred by insurance regulators is a letter of credit using the New York New York, state, United States New York, Middle Atlantic state of the United States. It is bordered by Vermont, Massachusetts, Connecticut, and the Atlantic Ocean (E), New Jersey and Pennsylvania (S), Lakes Erie and Ontario and the Canadian province of State wording (that is, clean, irrevocable Unable to cancel or recall; that which is unalterable or irreversible. IRREVOCABLE. That which cannot be revoked. 2. A will may at all times be revoked by the same person who made it, he having a disposing mind; but the moment the testator is and evergreen evergreen, term commonly used as synonymous with conifer and applied also to all those broad-leaved plants that bear green leaves throughout the year. Of the latter, most are plants of the tropics, subtropics, and other areas where the growing season is prolonged (e. ). The financial services department believed the most secure form to be this type of letter of credit, especially in the case of a bankrupt insured. Not having the correct form of collateral caused significant problems for the company in bankruptcy, collection and overdue situations. * Audit the contracts to make sure they accurately reflect the intent and working of each program type. To management's shock, the financial services department found that the contracts for the company's self-insured retention programs did not accurately reflect the workings of the program type. This oversight created an unfunded liability of $200 million for the company that needed to be addressed immediately and successfully. If possible, standardize stan·dard·ize v. 1. To cause to conform to a standard. 2. To evaluate by comparing with a standard. the contracts so that there is predictability in the business written. * Placing facultative facultative /fac·ul·ta·tive/ (fak´ul-ta?tiv) not obligatory; pertaining to the ability to adjust to particular circumstances or to assume a particular role. fac·ul·ta·tive adj. 1. reinsurance is usually an area that does not receive much scrutiny. On a total placement basis, you may be ceding cede tr.v. ced·ed, ced·ing, cedes 1. To surrender possession of, especially by treaty. See Synonyms at relinquish. 2. away too much profit. If so, you could self-fund this reinsurance and have a credit line and/or a stop loss cover to protect any unexpected overages. You may be able to do the same with your treaty reinsurance if you do not have catastrophe exposures. Reinsurance * When placing reinsurance, it is important to use reinsurers that are stable with regard to financial results, capitalization and location. Perform a review of your reinsurers every year to determine their long-term viability. Otherwise, you may find years later that you have no protection and have to take a hit to your bottom line. * When negotiating treaty and facultative reinsurance terms, get a portion of the ultimate expected reinsurance recoverables covered by a letter of credit. For example, using your loss experience, you can estimate the outstanding reinsurance recoverables at three years out and get collateral for that amount. This collateral can be used to reduce any schedule F penalties and possible default by the reinsurer re·in·sure tr.v. re·in·sured, re·in·sur·ing, re·in·sures To insure again, especially by transferring all or part of the risk in a contract to a new contract with another insurance company. . Actuarial ac·tu·ar·y n. pl. ac·tu·ar·ies A statistician who computes insurance risks and premiums. [Latin * It is important that there be continual education for the underwriters regarding loss-development factors, incurred-but-not-reported losses and the accurate application of the actuarial pricing methodology. Not having this education in place caused significant problems for the company, especially given the high turnover of underwriters in the field. The outcome of such a lapse (language) LAPSE - A single assignment language for the Manchester dataflow machine. ["A Single Assignment Language for Data Flow Computing", J.R.W. Glauert, M.Sc Diss, Victoria U Manchester, 1978]. is bad pricing, insufficient collateral amounts and inadequate aggregate/maximum premium limits. For example, the CFO See Chief Financial Officer. asked the financial services department to reunderwrite an account that appeared to be delivering unsatisfactory results. The financial services department was to use only information available to underwriting at the time the business was written. It was an incurred-loss retrospective account, and it was determined that the underwriter underwriter n. a company or person which/who underwrites an insurance policy, issue of corporate securities, business, or project. (See: underwrite) UNDERWRITER, insurances. One who signs a policy of insurance, by which he becomes an insurer. used loss data that was a year old to price the account, set maximum premium limits and determine collateral amounts. He did not apply actuarial loss development factors to the incurred loss amounts. Nor did he take into account that the company was growing at a 30% rate every year. In the contracts, he made no provision for audits to be performed. He never had financial reviews performed. The outcome was disastrous. Billing and Collections * On start-anew business, billing and collections personnel need to communicate with brokers/agents and insureds on an underwriting basis and not an accounting basis. Sending copies of ledgers or speaking in terms of debits and credits will not work. Bills need to reflect the terms of the contracts (deposit premiums, retrospective adjustments, deductibles, service fees, aggregates, maximum premiums). If not, the brokers/agents and insureds will not pay. This change was important, enabling the financial services department to achieve a 97% collection rate in two years. * Reconcile run-off business on an underwriting basis and not based upon what the ledgers show. Get the underwriting Files and determine what should have happened by way of contracts and endorsements. Compare this to what was actually booked and paid. Any difference on the ledgers can be marked off with confidence that you have the correct numbers. On this basis, the financial services department was able to identify and collect $100 million in previously unknown receivables and clear the ledgers. Audit * Internal audit needs to regularly audit underwriting for compliance on application of pricing methodology, depressing premiums and probable maximum losses Probable Maximum Loss (PML) The anticipated value of the largest loss that could result from the destruction and the loss of use of property, given the normal functioning of protective features (firewalls, sprinklers, and a responsive fire department, among others, in the , collateral and escrow/working fund amounts, financial reviews of insurers and contract wording. Without this process, catastrophic outcomes can, and many times do, occur. For example, it came to the financial services department's attention that the company's international operation was writing an increased number of captives, but no one was seeing any meaningful information on the captives. Financial services contacted the head of the international operation and queried him on this. He was not aware of the situation and requested that financial services go to his offices and audit the captives. This was done and the situation was not good. Five captives were putting the company at significant risk. In the worst case, the underwriter had artificially calculated a reduced probable maximum loss to avoid scrutiny. He had no backup for his estimated ultimate expected losses, saying that he just used what the broker told him. The policy limit per occurrence was $2.5 billion with a probable maximum loss of $20 million. Not much was excluded from the policy. The captive was responsible for the first $1 million of each occurrence. Much of the probable maximum loss was reinsured. However, it was largely assumed back by the company, thus leaving the company at significant risk with little protection. Needless to say, changes were implemented. Accounting * To improve accuracy of the ledgers, the financial services department instituted a daily procedure to reconcile the previous day's entries against the policy information received from the underwriter. If information was not available, accounting made sure they received it. If incorrect entries were on the ledgers, they were sent back to entry for correction. Accounting also checked each day that the corrective entries made the previous day were correctly entered. Performance measures were used to make sure the company stayed on top of this situation. * Unapplied cash resided in a number of accounts. It was imperative that these accounts be reconciled if the financial services department was to be successful in its collection efforts. Performance measures were used to drive success in this area. Corporate Governance Corporate Governance The relationship between all the stakeholders in a company. This includes the shareholders, directors, and management of a company, as defined by the corporate charter, bylaws, formal policy, and rule of law. The financial services department was given a veto of any business opportunities that were under its purview The part of a statute or a law that delineates its purpose and scope. Purview refers to the enacting part of a statute. It generally begins with the words be it enacted and continues as far as the repealing clause. . The purpose was to prevent the company from being adversely impacted by inappropriate business decisions made by those with authority in the field. Only the CFO could override An arrangement whereby commissions are made by sales managers based upon the sales made by their subordinate sales representatives. A term found in an agreement between a real estate agent and a property owner whereby the agent keeps the right to receive a commission for the sale of the financial services department's veto. For example, in an effort to reduce reinsurance penalties, the head of reinsurance was planning to draw down on letters of credit supplied by good reinsurers for their business to pay for delinquent reinsurers where an LOC An Loc (Vietnamese: An Lộc) is a small town in southern Vietnam, located approximately 90 km north of Saigon (Ho Chi Minh City) with a population of 15,000. The town became famous during the Vietnam War, as the location of a major battle in 1972. was not available. Another example dealt with underwriting wanting to use back-dated insurance policies as a way to cover business losses for companies, thereby improving their financial results. Of course, both are illegal and would have tremendously damaged the company's image. Having a knowledgeable brain trust such as the financial services department, that responded intelligently and quickly to all operational issues, greatly improved the financial results of the organization and prevented the implementation of bad decisions that would have created a public relations public relations, activities and policies used to create public interest in a person, idea, product, institution, or business establishment. By its nature, public relations is devoted to serving particular interests by presenting them to the public in the most debacle. Contributor Ian MacDonald Ian Macdonald may be
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