10 January 2020Accounting & tax analysis

Fighting to remain relevant

​In the mid-1980s, the liability insurance crisis made it extremely difficult for businesses in many industries to access affordable liability insurance. Companies in the business of manufacturing underground fuel storage tanks were no exception.

​“Developing a more diversified book of business will make STICO less vulnerable to the cyclical nature of the oil and gas industry, which should please AM Best.”In 1987, the trade association for steel tank manufacturers, the Steel Tank Institute (STI), began searching for a solution to a particular dilemma: traditional insurance companies refused to write pollution liability coverage for its industry at any price.

Further complicating matters was the existence of a 30-year warranty product that the manufacturers provided with each tank sold. The association needed to find an insurance carrier that was willing to both write the group’s liability coverage and take on the warranty liability. If it was unable to find such a partner, the association and its members faced an extremely uncertain future.

STI established an ad hoc committee to investigate possible solutions that included assembling an insurance purchasing group affiliated with one carrier. The carriers contacted viewed the issue of pollution in a macro sense and were unwilling to attach much value to the tank industry’s inherent underwriting and risk management expertise—including its technical acumen, quality control structure and tank management knowledge.

Over time, it became clear that the only viable solution would be to form a captive insurance company, with targeted coverage, under the control of the policyholders. In late 1987, the ad hoc committee’s work culminated in a recommendation to the STI board to create an association captive insurance company.

After making its recommendation to the STI board, the ad hoc committee undertook, with the help of insurance industry experts, a detailed feasibility study on forming a captive insurance entity. The study included an actuarial analysis, potential sources of capitalisation, tank manufacturer underwriting criteria, company management structure, domicile options, scope of liability coverage to be offered, policy language, reinsurance options and premium rates.

In early 1988, the STI board agreed to support the formation of the captive and, in July that year, the state of Vermont issued a certificate authorising the Steel Tank Insurance Company (STICO) to operate as a mutual insurance company. At the time of formation, STICO had 46 members, $5 million in assets and $4 million in capital and surplus. In the 31 years since, it has broadened its membership to include petroleum equipment contractors and related product manufacturers. In 2003 it converted to a risk retention group (RRG).

STICO currently writes commercial general liability and pollution liability coverage for over 120 members and holds assets valued at more than $24 million. It has over $13 million in capital and surplus—even after returning over $5 million to its membership in policyholder dividends since 2006.

STICO’s present
STICO has been a successful example of a captive formed to meet the needs of its members, but its story is not without turbulence. STICO experienced significant premium growth in the years following 2001 due, in part, to a more aggressive marketing strategy and an AM Best rating increase from B++ to A-.

However, it was also helped in large part by the hard market that followed the 9/11 terrorism attacks in 2001. When the traditional carriers are increasing rates and your captive has delivered 16 years of stable rates, it is not very difficult to draw new members, but all good things come to an end and the hard market of the early-to-mid-2000s was no exception.

The growth STICO experienced over its first 25 years slowed and then reversed as the soft market wore on throughout the 2010s. The traditional carriers, who were once afraid of covering storage tanks, began to return to the business. Some attempted to undercut STICO’s pricing by 20 percent or more in an attempt to buy market share. They had moderate levels of success in this, but then disappeared almost as quickly as they arrived.

Others have leveraged their large capacity and ability to write all lines given that, as an RRG, STICO can write only liability lines. This has been an attempt both to pilfer STICO insureds and to defend against its core competence of being a responsive and nimble insurance company with a singular market focus and lucrative dividend programme. This tactic has proved to be more problematic for STICO.

At the same time that competition increased within this niche, STICO’s members experienced two separate economic slowdowns. The first was related to the broad recession that began in 2008 and continued into the early 2010s. The second slowdown, arriving in 2016 and worsening in 2017, was specific to the tank and energy industries and stemmed from raw material cost uncertainties related to steel tariffs and fluctuating oil prices.

Because STICO’s premium is based upon revenue, these slowdowns adversely impacted written premium from existing members during those years.

Finally, AM Best, upon seeing three years of declining premium from 2015 to 2017, lowered STICO’s rating outlook to “negative”. Its primary concern related to risk distribution and the fact that STICO’s narrow industry focus made it susceptible to economic cycles within that industry. Due to its small size and fixed costs, consecutive years of declining premium wreaked havoc on STICO’s ratios.

To summarise STICO’s challenges over the past decade, while claims experience has remained relatively benign, it has had to contend with:
• A prolonged soft insurance market that has exerted significant downward rate pressure;
• An increase in competition in its niche that has made attracting new members and retaining existing members much more difficult;
• Tank industry-specific economic headwinds that have lowered premium from existing members; and
• The prospect of a rating downgrade that, if enacted, would cause it to lose over 50 percent of its members who contractually require A-rated paper. In the meantime it serves as a significant obstacle to growth.

STICO’s future
STICO knew that the economic environment for its membership was improving, while premiums looked likely to increase in 2018 and 2019. However, it knew that the traditional carriers in its space weren’t going to be as accommodating. It needed a strategy to address both member retention and new member growth in the face of continued competition.

Member retention
STICO has operated a formal policyholder dividend programme since 2006, where 60 percent of net income before taxes is returned to the policyholders each year. On average, its members have received 15 percent of their premium back through this programme. Further, it began including each member’s individual dividend history on their renewal proposal each year as a reminder of this key benefit.

However, STICO also wanted to create a number of value-added programmes to offer its membership that would augment its existing risk management and policyholder dividend programmes. It wanted its members, at the time of their annual renewal, to say to themselves: “If I leave STICO, I will really miss X, Y and Z”.

Among these programmes, all instituted in 2018, was a hyper-focused periodic newsletter available only to members and their agents, and a sales contract review programme, with a third-party legal review of its members’ sales contracts with their customers. It also provided the published results of a 50-state survey STICO conducted in order to determine the enforceability of indemnity clauses that its members often find in their sales contracts.

All have been very well received. STICO experienced a sharp drop in departing members in 2018 and 2019—from an average of six or seven per year to two or three per year.

Membership growth
Attempting to grow a mature company in a soft market is a difficult prospect. However, STICO has enacted a number of initiatives that are beginning to yield positive results.

First, it addressed its distribution channel. In STICO’s early days, 80 percent of its policies were sold directly to the insured. Now, 90 percent of its policies are sold through the insured’s retail agent. Therefore it has had to develop an agency outreach programme to make retail agents throughout the US familiar with STICO and the value proposition it can provide to its clients. As it has developed a network of “friendly” agents, the number of new business submissions has increased substantially.

Second, STICO hired a dedicated salesperson to focus exclusively on managing those agency relationships and produce new business. He has been “planting seeds” for the past 18 months and the group was starting to see the fruits of that labour in 2019, quoting more than 10 times the amount of new business than it did in 2018.

Third, STICO has worked to improve its product by developing a combined limit (hybrid) commercial general liability (CGL)/pollution policy that can be sold at a discount to its standalone policy forms. This has been extremely well received in the marketplace, representing more than half of STICO’s new business in 2019, despite being introduced to prospective members only in July.

Fourth, STICO is looking to expand its industry focus outside of petroleum and water processing and storage. A number of industries, such as food and beverage, have very similar manufacturing processes to STICO’s core group of manufacturers. The RRG believes that its value proposition would very easily resonate with these businesses.

Given its growing network of agents, reaching these companies won’t be as cumbersome as it otherwise could have been. Further, developing a more diversified book of business will make STICO less vulnerable to the cyclical nature of the oil and gas industry, which should please AM Best.

Finally, STICO is working to address what can be called “the RRG issue”. Being structured as an RRG provides many advantages, but the primary disadvantage is not being able to provide all lines of coverage that its members require.

STICO’s A- "V" categorisation - an AM Best scale grouping institutions by size - can also be a hindrance when a prospective insured must show evidence of coverage from a carrier rated A-, VIII or higher. STICO is currently investigating a number of options, including a partnership with a carrier to write the lines that it cannot, gaining coverholder status with a carrier or carriers and/or entering into a fronting relationship, that could help solve this problem.

Since enacting these various efforts, STICO has recorded excellent results. Its written premium grew nearly 20 percent from 2017 to 2018. In 2019, written premium was predicted to grow another 24 percent, and by 8 percent in 2020.

Some of this growth is certainly attributable to the current strong economy, but STICO believes its efforts to expand its industry focus, address member retention, enhance its sales and distribution channels and improve its product itself will pay dividends well into the next decade.

Colin Donovan is president at STICO Mutual Insurance Company. He can be contacted at:  colin@stico.org