Little Fish: Buffeted by larger forces but anchored in their markets, small companies hold onto their place in a changing industry. (Market Competition: The Big Picture).

They can be nimble, focused, light on bureaucracy and close to their agents and customers. They also can be thinly capitalized, sparsely staffed and too concentrated for comfort in one region or one line of business. Small insurers--regional players, county mutuals, specialty writers, home-service life companies--abound in the U.S. market, resisting the forces of consolidation and maneuvering in the wake of larger competitors.

Small size in an insurer carries few absolutes that don't apply to large companies as well. But in an industry where strategic discussions ring with phrases such as economies of scale and critical mass, small insurers have advantages that are hard to duplicate in a large company--and potential problems that big organizations are less likely to face.

One ingredient few small companies have under their own roof is their distribution system, and it's the first topic that surfaces in most discussions of such companies. Successful small companies get this part right.

"They typically have a very good relationship with their customers and/or their agents," said Rodger Lawson, president of the Alliance of American Insurers. Most small property/casualty insurers are agency companies, and they get to know their agents, markets and risks very well, he said.

Ties That Bind

The bond with agents and customers is more than a feel-good factor. The federal USA PATRIOT Act, for example, puts insurers in the awkward position of looking for known terrorists among their clients. But in the case of very small insurers, "the managers quite literally know all their customers," said Mike Happe, vice president of member services with the National Association of Mutual Insurance Cos.

Small life insurers, too, have tighter distribution systems, usually through captive agents, even as many larger companies jettison their career agency forces. It involves "a lot more close supervision, because it has to be," said Scott Cipinko, executive director of the Life Insurers Council. The council, an arm of LOMA, the life industry research and educational organizations, has many small life insurers among its members.

Knowledge of the producers often ties directly to knowledge of the customers and risks a small company chooses to write. Smallness lends itself to paying undivided attention to a circumscribed Market--be it a geographic region or a line of business. With less information to digest, "it's easier to get a handle on what's going on and to price. that," said Lawson.

In the life business, companies that are small enough to still send agents door-to-door continue to benefit from face-to-face contact. It's a throwback to a time when more life agents had firsthand knowledge of their customers changing circumstances-weddings, births, promotions and retirements. "It was that kind of trust relationship people had with the agents," Cipinko said. "They were part of the family."

Small companies tend to be staffed with pure, well-trained insurance professionals who can bring the full weight of their knowledge to bear on a concentrated area, Lawson said. Those experts operate in an environment that's usually less bureaucratic, allowing for quicker decision-making than might be possible in a large organization. It can be easier for a small company to innovate, change forms and coverages, or move into new territories or lines of business quickly, said Happe.

Small life companies have been hotbeds for innovations that larger companies later copied, Cipinko said, citing examples such as universal life and accelerated benefits. The focus on creativity, in part, reflects the difficulty small companies have in competing on price, and it's one reason large life companies like to buy small ones, he said.

Close ties with local regulators also can help to grease the skids when a small company makes adjustments, Happe said. "You know your regulators really well, and they know you," he said. Mere physical proximity to the regulator can be an advantage. With companies' rates and forms publicly available at the state insurance department, an instate company can easily pay a visit and see what its competitors, large and small, are doing, Happe said.

While some small companies rely heavily on resources such as Insurance Services Office Inc. or the American Association of Insurance Services for forms and loss costs, others depend less on such services; instead, they use their agility and their regulatory relationships to develop and gain approval for products tailored to the local marketplace, said Happe.

Fearing Federal Regulation

A more widely used resource among small companies is state and national trade groups, which can be vital sources of local market intelligence, while giving small insurers strength in numbers when it comes to both state and federal lobbying. One subject that sends a shudder through the small-company ranks is the thought of federal regulation--even in a limited form such as an optional federal charter. It's widely believed that such an option would appeal most to large, national companies, and the fear is it would become a competitive advantage for big insurers.

"If the federal charter was less costly to comply with...then obviously you could have a situation where there would be a cost differential," Lawson said. What small insurers hope to avoid is two kinds of regulation--"costly and less costly," he said.

Lower face value life business, which Cipinko sees as an important and neglected sector where small companies can play, also happens to be the most tightly regulated, imposing prohibitive costs on those companies, he said. Cipinko said he's been talking with Mike Pickens, the Arkansas insurance commissioner and president of the National Association of Insurance Commissioners, about "real regulatory reform" to ease that source of pressure on life companies' expenses.

Technology for All

A gap that's been shrinking between large and small companies is technology, Happe said. With desktop computers packing the power that a mainframe did 10 years ago, and Webbased tools widely available, smaller companies can tap into technology that once was too expensive; some even are using scanning technology to migrate to paperless environments, he said.

Happe said he has seen impressive applications of technology at small companies. One example: a Utah insurer with an earthquake-resistant, underground computer room, where cables are strung from the ceiling and coiled with eight feet of slack to allow for the motion of the room should a major quake occur.

The efficiencies gained from technology are one way to attack a persistent bugaboo of small companies--the expense ratio, which tends to be higher than at large companies. But these companies often make up the difference in their loss ratios, where the keen focus on fundamental underwriting yields results that can be the envy of larger competitors.

In 2002, for example, companies with policyholders' surplus of less than $100 million had a loss and loss-adjusment expense ratio of 74.6, compared with 81.8 for their larger counterparts, according to A.M. Best Co. data. But the small companies' expense ratio was 29.7, compared with 25 for the larger companies. Overall, the small companies emerged with a modest advantage in their combined ratio--105, vs. 107.5 for the large companies.

Through Thick and Thin

For all their flexibility, small companies can be constrained by their capital structures, which tend to limit their ability to grow or to enter and exit markets. The small insurers' commitment to clearly defined markets is a long-term strength that customers appreciate, but it exposes such companies to a recurring nuisance--the movement of larger insurers in and out of their markets in time with the underwriting cycles. In soft markets, the big players seek places to deploy excess capital, and sometimes they land on the turf of a small insurer, adding a new element of competition. But those large companies' commitments are more conditional, and they can depart as quickly as they arrive when the returns deteriorate. That leaves the local companies to handle a disrupted market--but also to reap the gratitude of orphaned customers.

"Thank goodness there are those small companies," Lawson said.

As much as they value long-term relationships with their customers, small companies look for the same thing when they become the customer--of a reinsurer. While some small companies have excellent, longstanding partnerships with their reinsurers, they haven't been exempt from the capacity crunch that has plagued the entire industry, particularly since the terrorist attacks of Sept. 11, 2001. But Lawson said it's affected companies of all sizes about equally.

He noted that many small companies are writing either "plain vanilla" or specialty coverages, which helps them in the reinsurance market. "The larger you get, typically the more you're in difficult markets," Lawson said.

For small life insurers, consolidation among their reinsurers has been a major challenge, making it increasingly difficult for such companies to diversify their reinsurance programs across multiple carriers, Cipinko said.

"It's a difficult environment for reinsurance for every size company," Happe said, although he stressed, "This varies by state, it varies by product line, it varies by health of a company." Smart executives, he said, "are pushing back on their reinsurers."

"For the savvy guys who know how to shop it--it's not hurting some companies as much as it's hurting others," Happe said.

A Small Bench

The chief executive officer at a small company can take on special importance, and the departure of a strong personality at the top of such a company might leave a void that's hard to fill. "When the time comes for leadership change, that's a very challenging period, particularly for the small and medium-size companies," Lawson said.

"The smaller the company, the more and more difficult it's becoming" to achieve smooth management succession, Happe said. An obvious difficulty is the lower pay that small companies tend to offer, he said.

"It's also tough because some of the companies are in a small town," Cipinko noted. "You've got to want to live in a small town." Instead, the best management material often moves on to bigger companies offering more money, he said.

"I think there is a real problem there, because they don't have big staffs to begin with," Lawson said.

Small companies often find themselves looking to their boards of directors or their agency networks, rather than within their own management ranks, for candidates to fill top vacancies, Happe said. Succession issues are a leading cause for mergers among small companies, about on a par with financial difficulties, he said.

Those financial difficulties, especially for property/casualty companies, can be as close as the next tornado that slices through a small insurer's core territory. The very focus that keeps a small company firmly established in its market can also concentrate its exposure, leaving it susceptible to even a localized catastrophe or a shift in the regional business climate.

The future looks "treacherous" for small life companies, squeezed by weak capital markets, regulation and pressure to cut costs, Cipinko said. It's becoming "very difficult to find any fat" for such companies, he said. But if companies can cut costs--perhaps with a boost from regulatory reform--that could help to compensate for the difficulty companies now face on the investment side, he said.

The industrywide march toward consolidation awaits small companies that, through bad luck or miscalculation, find themselves unable to go it alone. For Lawson, the trend looks unavoidable: "It's likely that over time, there will be fewer of those companies out there."

Measuring Up

Large and small property/casualty insurers moved in lock step by some
measures in 2002, but aggregate loss and expense ratios highlighted
relative strengths and weaknesses in the two groupings. Small companies
enjoyed an advantage in their loss ratios, but economies of scale gave
large companies the edge on expenses.

($ Thousands)



                                             12-                    12-
                                    Net    Month                  Month
Company Size                   Premiums  Percent                Percent
By Policyholders' Surplus       Written   Change           PHS   change

Greater Than $100 Million  $356,994,389     15.0  $276,286,179     -1.1
$100 Million or Less        $20,068,972     15.2   $14,368,784     -0.4

                                    Pretax
                                 Operating                   2000
                                   Income/              Loss/Loss
                                       Net      Total  Adjustment
Company Size               NPW/   Premiums     Return     Expense
By Policyholders' Surplus   PHS     Earned  on Equity       Ratio

Greater Than $100 Million   1.3        2.4       -5.1        81.8
$100 Million or Less        1.4        2.2       -3.3        74.6



                                   2002
                           Underwriting      2002
Company Size                    Expense  Combined
By Policyholders' Surplus         Ratio     Ratio

Greater Than $100 Million          25.0     107.4
$100 Million or Less               29.7     105.0

Source: A.M. Best data

Insurers Great and Small

Aggregate 2002 figures for large and small life insurers differ in more
than size with small companies growing, faster in net premiums
written--but posting lower after-tax net operating gains. Small
companies grew in key sectors, led by individual annuities and group
health, but the corresponding surge in expenses hit their operating
results. Large companies' premiums reflected lower demand for variable
products.

($ Thousands)

Company Size                                        Net  12-Month
By Capital & Surplus +           Admitted      Premiums   Percent
Asset Valuation Reserve            Assets       Written    Change

Greater Than $100 Million  $3,344,830,067  $582,949,037       4.9
$100 Million or Less          $62,501,409   $15,885,737      15.6


Company Size                   After-Tax  12-Month
By Capital & Surplus +     Net Operating   Percent         C&S +
Asset Valuation Reserve             Gain    Change           AVR

Greater Than $100 Million    $18,728,156      12.9  $213,113,981
$100 Million or Less            $352,394     -10.2    $7,158,067

                                        Adjusted
Company Size               12-Month         C&S/
By Capital & Surplus +      Percent     Adjusted
Asset Valuation Reserve      Change  Liabilities

Greater Than $100 Million       0.0          9.8
$100 Million or Less           -0.1         15.1

Source: A.M. Best data