Western National Insurance.

Pesch, Michael J. ; Eide, David L. ; Moorthy, Subba 等

CASE DESCRIPTION

The primary subject matter of this case concerns the approaches used to methodically turn a financially struggling insurance company into one of the top regional insurers in the Midwest. Strategy formulation and execution in the insurance industry, aligning functional strategies to support the organization's strategy, and leadership competencies in turnaround situations are major themes. The case has a difficulty level of 3-5 and is appropriate for junior and senior-level courses, as well as a first-year graduate course. The case is designed to be taught in a ninety-minute class period, with two hours of outside preparation by students.

CASE SYNOPSIS

An insurance company is at risk of falling into a financial death spiral and brings in a new CEO to turn the company around. The CEO and his team take specific measures to bring the company back to financial health. These include mitigating risk, branding the company, solidifying agent relationships, ramping up technology, overhauling facilities, diversifying the business, and becoming an employer of choice. Growth has stalled and the company now is considering whether to change its business model from selling insurance products solely through independent agents to also selling directly to consumers via the Internet and an internal sales force.

INTRODUCTION

In September 2009, Stu Henderson, CEO of Western National Insurance, celebrated with his employees the announcement that A.M. Best, the premier insurance rating agency, had upgraded Western to a full A (Excellent). With this upgrade, Western became the only insurance company in the nation to be upgraded three times in the past eight years on its own merits, i.e. without external capital injections. This announcement came only two months after Western was named for the fourth time in five years to the Ward's 50 Benchmark Group of top performing property/casualty companies in the United States. (Ward's is an independent consulting firm. Each year, based on published financial numbers, they select the top 50 property/casualty insurance companies among the 3,000 companies that operate in the United States. Return on surplus, combined loss ratio, and other factors are compiled to determine this prestigious ranking.) In the crowded cafeteria, Henderson held up his can of diet ginger ale and made a toast:

At a time when the economic news has many thinking that financial stability is the exception rather than the rule, we are pleased to have first the Ward Group, and now A.M. Best recognize Western National's role as an insurance industry leader in financial strength and performance. We owe this recognition to the dedicated work of our employees, agents, and other business partners, whose commitment to serving customers with integrity continues to strengthen the financial foundation protecting our policyholders.

As Henderson looked out at the gathering of smiling employees, he savored the moment and considered how far the company had come in the past eight years. In 2001, Western was in a financially precarious state where a single catastrophic storm easily could have pushed the company into bankruptcy. Clearly, the company journeyed a long and difficult path to bring itself back to financial health.

As much as he enjoyed the celebratory atmosphere, Henderson also recalled the old adage that the moment you think you've accomplished all your goals is the moment your position of strength starts to erode. Aware of the danger of complacency, Henderson was already considering how Western could get stronger.

A dilemma that Henderson and his team had pondered for several years was whether Western should rethink its business model of selling all of its insurance products through independent agents instead of selling directly to the public. The direct sales model had several advantages, including the savings of agent commissions, having more control over the policyholder relationship, and the availability of the Internet and information technologies to provide efficiencies and superior service.

On the other hand, selling insurance directly to the public had its potential pitfalls. Several much larger companies such as Progressive were already selling insurance on the Internet. These companies had larger financial resources to advertise and move traffic to their websites. Setting up the internal sales and operations capability to sell direct was also costly, involving more staff, training expense, and additional investments in information technologies.

Although it was easier to stick with a model that worked well for Western in the past, Henderson wondered if the changing environment in coming years required an overhaul of Western's sales approach. In the past ten years the public had become increasingly comfortable with shopping on the Internet for almost anything, including insurance. If Western failed to adapt to emerging trends in the way people buy insurance, it could have significant and long-term financial consequences.

But first, it was time to celebrate. Henderson put his soda can down and announced, "Let's cut the cake!"

U.S. PROPERTY CASUALTY INDUSTRY

In 2009, the United States property/casualty insurance industry wrote approximately $475 billion in coverage. The top ten national companies (e.g. State Farm, Allstate, Travelers, Progressive, Nationwide) write approximately 50 percent of the total coverage, or $240 billion. There are about 3,000 companies that write some form of property/casualty insurance in the U.S.

How Insurance Companies Make Money

An insurance company is deemed financially successful if its losses paid, expenses incurred (including commissions, claim adjustment costs, salaries, and general overhead) are less than $1.00 of each dollar of premium revenue earned. This measure is called a "combined ratio." If an insurance company has a combined ratio under 100, it is profitable. For example, a combined ratio of 96 means that for every $1.00 of premium earned, the insurance company is realizing a profit of 4%.

An insurance company also receives income from investments held either as loss reserves (money waiting to be paid for losses either incurred or expected to be incurred in the future) and income from investments held in the form of policyholder surplus. Today, most insurance companies are earning around 5% on money held in these two categories. So if the combined ratio is 96 (4% profit) with an investment return of 5%, total net income before taxes would be the sum of the two pools of income.

COMPANY BACKGROUND

Western National Insurance Group, headquartered in Edina, Minn., was a super-regional property-and-casualty insurance group writing over $245 million in direct premium in nine states, serving personal and commercial customers in Minnesota, Nevada, Oregon, South Dakota, Utah, Washington, and Wisconsin, as well as commercial customers in Iowa and North Dakota. All of the group's products were sold exclusively through professional independent agents.

Western began more than 100 years ago as a Minnesota company called "Mutual Creamery and Cheese Factory Insurance Company." As the name suggests, it was founded to provide specialty insurance coverage primarily for creameries. Creameries were the owners of the company and paid premiums to the group in return for casualty coverage, and all sales were "direct" to the customer by company employees.

In 1955, Western hired George Klouda to expand the product line to include liability, auto, and other lines of property/casualty insurance, and to open sales through independent agents to a wide range of markets, companies, and individuals. Klouda rose to CEO and served in that role until 1997 when Don White was hired to take over the president duties. However, despite being president, White was not given a seat on Western's board. The most important decisions continued to be made by Klouda (who retained his titles of CEO and Chair of the Board) and four other board members, all of whom had been nominated by George Klouda.

Starting in the mid-1990s, Western's financial health began to suffer. With Western trying to position itself in the market as a low-rate insurance provider, rate increases were sporadic and insufficient. Rates were increased only a couple of times in the 1990s, and by the end of the decade, rates were grossly inadequate to cover underwriting expenses and loss risks of outstanding policies. For example, by 1999, Western's combined ratio for its standard auto insurance was approximately 130 percent (i.e. the company was losing 30 cents for every dollar of premium collected). The company was also writing a substantial amount of building contractor's insurance at rates that were insufficient to cover claims for shoddy work and building code violations.

Another problem was Western's failure to maintain adequate loss reserves to fund expected future claims. Claims on liability policies, i.e., general liability, automobile liability and workers compensation may take years to resolve. As such, an insurance company estimates what those costs will be and sets aside loss reserves to cover these future payments. Despite the uncertainties in setting loss reserve levels, prior loss reserve experience clearly indicated that Western's reserves were well short of covering claim levels that could typically be expected. In addition, the company was growing homeowners business in very concentrated areas, underestimating the possible loss due to adverse weather (tornados, hail, etc.) occurring in one of these areas.

Insurance companies traditionally buy insurance themselves, called "reinsurance," to cover significant loss events. Reinsurance allows a company to absorb a huge financial shock when unusually severe storm activity results in extremely high claims. Rather than dealing with a huge financial hit of tens of millions of dollars in claims all at once, with reinsurance, a company pays annual premiums that are more consistent and predictable, tapping this coverage when a high claims year inevitably arrives.

Western carried insufficient reinsurance coverage to protect against exceptionally high storm claim events, a problem which came to light when a huge storm loss in 1998 generated claims totaling $56 million, with the company's reinsurance covering only $20 million. Prior to 1998, the largest claim total for Western from a single storm event was $3 million. With inadequate reinsurance to pay the 1998 claims, Western had to draw down its surplus from $72 million in 1997 to $58 million in 1998.

Western's financial predicament was not surprising, given that the company did not conduct formal budgeting or planning, did not map insured properties and model storm effects, and did no industry peer-group analysis for benchmarking and strategic goal-setting. Most of the problems could be traced to poor leadership at the very top of the company. With a residence in Florida, the CEO was not fully engaged with running the company. He did not delegate major decisions-making responsibility to his officers, and financial information (balance sheets and income statements) was prepared only on a quarterly basis to fulfill legal requirements, and not shared with the company's officers.

Most of the officers knew Western was not doing well, but they were isolated by the lack of full information and by goal conflicts among the officers in their respective roles. For example, while the actuarial department determined that personal home and auto rates were too low to cover losses and expenses, the sales department resisted rate increases for fear they would depress policy renewals and sales of new policies. The lack of top leadership meant these internal conflicts would usually go unaddressed and be allowed to inflict serious financial damage on the company. According to one long-term Western official, "Our CEO at the time, while smart, did not change with the times and his leadership was very hierarchical. Managers were followers, not leaders. They did not appreciate the desperate financial situation the company was in. They didn't understand financial statements because their jobs weren't driven by them."

The company also lagged in adopting new technology. For example, when reinsurers asked Western to map the homes covered by its policies in order to assess vulnerability to storm events, the company lacked the computer capability to conduct the analysis. Additionally, underwriting, claims processing, and billing were labor intensive and paper-driven.

Once an insurance company begins to struggle financially, it becomes increasingly difficult to reverse the decline because financial stability is the driver in writing new business and retaining existing contracts. In 1999, to communicate serious concerns with Western's financial viability, A.M. Best issued a double downgrade in Western's financial rating from A-directly to B+ (skipping B++). The A.M. Best downgrade was the result of several indicators showing that Western had entered a potentially fatal period of decline. The loss ratio (losses to premiums) was too high, the surplus was dangerously low, reinsurance continued to be insufficient to buffer against major claims, and despite low profits, dividends continued to be paid to policy holders.

COMPANY TURNAROUND

In 2000, pushed by the A.M. Best rating downgrade, Western conducted an external search for a new CEO. An executive search firm found Stuart Henderson to become Western's next leader.

Prior to joining Western, Stuart Henderson graduated Magna Cum Laude with a BA in Political Science from the State University of New York at Geneseo. He earned the Juris Doctor degree from Union University, Albany Law School, in Albany NY in 1980, and completed his Chartered Property Casualty Underwriter (CPCU) certification in 1991. Over the next twenty years, Henderson worked in a wide range of capacities as a lawyer and a manager, with most of his experiences in the insurance industry. He served as a claims counsel, and held various management positions in claims, underwriting, actuarial, product development/compliance, and a brokerage operation. His executive management experience included participation in the demutualization and initial public offering of Farm Family (NYSE), and serving as Vice President in the Casualty Underwriting Division of Gerling Global Reinsurance Corporation of America, Senior VP of Gerling's Property Underwriting Division, and General Manager for Gerling's primary insurance subsidiary, Constitution Insurance Company.

Although Western's challenges were serious when Henderson joined as CEO, he accepted the position because he felt the company had a number of strengths that offered hope for a recovery. First, the workforce was seasoned, knowledgeable and loyal to Western. Second, the network of independent agents that sold Western policies was largely pleased with Western's service and incentives, and committed to helping Western succeed. Third, the investment portfolio was strong in terms of safety and yield rates. Fourth, the claim staff was internal to the company, not outsourced, and provided accurate and fair claim processing and high levels of customer service. Fifth, customer relationships with policy holders were solid, since Western never had failed to honor a legitimate claim. Western also had good relationships with the insurance regulatory departments in the states in which it did business and was not burdened by any significant debts, liabilities or lawsuits.

In addition to Western's internal strengths, Henderson believed that there were positive dynamics in the insurance industry that would favor chances for Western's resurgence. First, rates in general were on the rise, especially in commercial lines, although Western did very little business in the commercial area in 2001. Second, the business model of selling insurance through independent agents continued to survive, despite the conventional wisdom that it would be replaced by direct selling to consumers over the Internet. Finally, large national insurance carriers tended to be fickle, quickly pulling out of markets where significant losses were incurred. This reduced rate competition in those markets and provided opportunities to Western and other medium-sized regional carriers with a longer-term view of these markets.

Initial Actions

Stuart Henderson took the CEO helm in late 2001. Before moving to Minnesota, he took advantage of the fact that rating company A.M. Best's New Jersey headquarters office was fifteen minutes from his home and drove over to meet with A.M. Best officials. He asked them not to further downgrade Western's rating, citing Western's experienced and customer-focused staff, its independent agent network that was still selling Western policies, and its strong investment portfolio. Henderson acknowledged A.M. Best's concerns with Western's financial vulnerabilities and emphasized that he intended to immediately start working on mitigating risk, boosting profitability over premium growth, and increasing reinsurance coverage.

In his first day as CEO, Henderson met with Western's top managers (with the prior CEO and board chair) to introduce himself and to reassure the managers that no immediate major changes would occur. He told them it was his intent to work with them to review the operations and plans of the company over the next 60 days to determine how best to move the company forward.

After meeting with top management, Henderson and the top managers held an all-employee meeting in the company cafeteria. Henderson pledged to the employees that he would learn about the company, its staff and independent agents, and preserve the good things that were part of the Western legacy. Additionally, he would seek every opportunity to strengthen the company and secure its future success, to maintain open communication channels, and to be honest and fair.

In the following weeks, Henderson held individual meetings with department heads, as well as meetings with departments as a whole to discuss processes, procedures, issues, and concerns. Henderson asked employees to critique their areas and list strengths and weaknesses. He would often ask employees, "What are your main worries concerning your area?"

Independent Agent Relationships

Henderson knew that Western's independent agent network was the "life-blood" of the company and it was critical to convince agents that Western was a strong and trustworthy business partner. He began by sending an open letter of introduction to the agents to thank them for their past and future support and to affirm Western's commitment to providing them with outstanding insurance products, excellent customer service, and competitive commissions. Shortly after sending out the letter, Henderson brought agents from Western's top ten producing agencies to the company's headquarters in the Twin Cities to meet with them personally. As Henderson recalls:

"They were a tough crowd--extremely focused on gauging where this company was headed. They told me "Don't change the culture. We like Western's customer orientation and prompt service." They also told me, "Don't take away the 'no-surcharge' (for accidents or traffic violations) feature of your policies, because policy holders like it, even if the majority of them never need it."

Over the next several months, Henderson traveled to meet individually with independent agencies to continue his on-going efforts to build solid relationships with those whom Henderson called, "our primary customers."

Reinsurance

Reinsurance was an area that needed immediate attention. Without adequate reinsurance, another major catastrophic storm could send Western into a financial death spiral. The company's low surplus level made its financial solvency extremely vulnerable to a year of heavy storm damage claims.

To bolster Western's reinsurance, Henderson engaged a reinsurance broker at Aon Benfield with whom he had extensive experience and could trust to become a long-term partner with the company. Using $11 million in earnings expected over the year from Western's investment portfolio, Henderson asked his new broker to give him the best reinsurance coverage possible for that amount. The broker was able to secure a policy that provided Western with better coverage and saved the company $1 million over what the previous reinsurer would have charged for the same coverage. By making the researching, negotiating, and purchasing of reinsurance a top priority, Henderson established a strong financial safety net for the company.

Mitigating Risk

Despite the increase in reinsurance, Western still had too much exposure to catastrophic claims and it simply didn't have the funds to purchase additional reinsurance. Homeowners insurance drives catastrophic claims exposure, and 35 percent of Western's total premium came from homeowners policies in 2001. Since there were no more funds to purchase more reinsurance, Henderson and his senior management team moved to reduce Western's home owners insurance business by 25 percent. To make the reduction as quickly as possible, Western contacted the top three homeowners insurance writers in its network, all of which were banks that were packaging Western homeowners policies with mortgage loans, and told them to move the business to other insurance companies. Although this meant a significant reduction in Western's premium revenue, catastrophic claim exposure was reduced and the disruption of important relationships with most of the independent agents was largely avoided.

To more effectively manage future growth in homeowners insurance and the attendant exposure to catastrophic claim risk, Western implemented a policy of writing homeowners policies only if they were packaged and sold with auto insurance. Additionally, Western developed Global Positioning System (GPS) mapping capabilities to identify geographic areas where Western homeowner policyholders were highly concentrated. These clusters of policyholders were more likely to occur within densely populated metropolitan areas, exposing an insurer to greater catastrophic damage claims if a storm should hit in one of these areas. The mapping technology allowed Western to stop writing new homeowners insurance in identified cluster areas.

Expansion of Commercial Lines

In 2001, Western's business was primarily comprised of auto and homeowners policies sold to individuals. As the new CEO, Stu Henderson saw advantage in broadening Western's product line by expanding insurance products for the commercial market, including the areas of property, liability, auto, and workers' compensation. Commercial lines were a valuable source of new premium revenue for Western to replace the premium lost from the reduction in homeowner policies, and to help achieve the strategic goal of growing premium over the long term. Commercial insurance also provided Western with greater market and risk diversity in its policyholder portfolio.

To profitably expand into the commercial insurance market, Western set an ambitious goal of writing an average of $50,000 in premium per commercial client. There were several strategic reasons why Western used this financial benchmark in pursuing the commercial market. First, it encouraged agents to package multiple insurance products (property, liability, auto, and workers compensation) for a given client, providing better overall coverage for the client at more competitive rates. Second, selling a larger and more comprehensive insurance package to commercial clients promoted the goal of developing close and long-term agent-client relationships. Finally, earning more premium income from clients who become long-term customers was an ideal strategy for controlling Western's expenses.

Increasing Profitability

In 2000, Western's premium rates in personal lines (home and auto) were too low to cover losses and expenses. Additionally, rates in commercial lines had been forced down due to market competition. In 2001, the company began to reposition itself in the market from being a low-cost provider of insurance products to being a high-service/long-term partner to its customers. This allowed the firm to begin increasing premiums to better match risks and expenses. Fortunately, this strategy to increase premium revenue coincided with the start of a period of rate increases in the insurance industry as a whole, known as a "hard market." The hard market made it easier for Western to adjust rates upward since the competition was doing it as well.

Stu Henderson also worked with Western's commercial underwriters to pay special attention to applicants who had loss histories that were less than perfect. While other insurers may not write policies for such applicants, Henderson encouraged his staff to study these applicants to determine if their losses were due to a temporary period of bad luck, rather than indicative of a long-term bad risk. Such clients could be very profitable if Western structured the premiums and coverage appropriately.

Western's GPS technology to locate insured properties was used in conjunction with software to conduct "what if" analysis for potential storm event scenarios. The technology allowed Western to make better decisions in writing new policies and setting premiums.

Credit scoring was another tool Western adopted to boost profits. Research shows that credit score is a strong predictor of an applicant's future claim risk, and by the early 2000s, many of Western's competitors had been using credit scoring for several years to screen applicants. Western's adoption of credit scoring allowed it to more accurately gauge the loss risk of an application and set premiums accordingly.

Controlling Expenses

One of Western's strengths when Stu Henderson joined the company was its low expenses (advertising, salaries, commissions, taxes, and other operational expenses) of 22-23% of total premiums. Keeping expenses low was important to the pursuit of bringing the company back to profitability.

One-half of Western's expenses were comprised of commissions paid to independent agents. Since there are both fixed and variable costs associated with maintaining independent agent partnerships, Western conducted a review of its agents to evaluate the return on investment in each of its agent relationships. Agents were evaluated on the basis of overall profitability and total premiums generated from their policyholders. A tiered commission structure was developed to pay greater commission rates to higher performing agents, provide incentives for agents in lower tiers to boost their productivity, and reduce commissions paid to low performers who might be candidates for culling from Western's independent agent ranks. The tiered commission mechanism helped Western target rewards according to agent performance in pursuit of a higher return on agent investments.

Branding

To refresh its image and to help distinguish itself in the insurance marketplace, in 2003 Western hired an outside branding company. With the branding firm's assistance, and after conducting research and internal study, Western leaders objectively characterized the company as a "B" player in the insurance industry, selling a medium-priced and fairly generic product. The next step was to gather responses from Western employees, independent agent partners, and policy holders to the question, "Why would someone do business with us?" The answers included: "People like us." "We answer the phone." "We take care of people's problems." "We listen." A common theme emerged on which Western could build a positive market presence by projecting itself as "The Relationship Company" and by incorporating this slogan into a revamped company logo (Figures 1 and 2). Western's new marketing thrust became the branding of Western as "The Relationship Company."

[FIGURE 1 OMITTED]

[FIGURE 2 OMITTED]

Facilities

Western's physical plant sorely needed updating. For example, the front steps and entryway were covered by worn indoor/outdoor green carpet. Inside, the building was dark and suffered from years of deferred maintenance. A fully-stocked bar in the boardroom projected an image of days past. The building lacked a training room for employee development and space for meetings with agents, regulators, and policy holders. In many other ways the building was ill-suited for supporting Western's operations and providing an aesthetically inviting work environment.

In 2005-2006, Mary Manley, Senior Vice-President of Corporate Affairs and Administration, was charged with a major renovation to Western's headquarters building. Major portions of the building were gutted, walls were removed, the bar was abolished, and a new expansive reception area was created. New offices for senior leadership were designed to facilitate easy communication and to create a bright and pleasing environment to welcome visitors. Paintings by local artists were purchased and hung in hallways, offices, and meeting rooms. A spacious training room with state of the art technology became a multi-purpose venue for employee development, agent training, and board meetings.

A key element of the building renovation was the construction of a new cafeteria. According to Manley, creating an attractive cafeteria gathering space fit well with Western branding itself as "The Relationship Company," noting that the culture required that not all renovations be directed to senior management spaces. New ceilings, lighting, and remodeled bathrooms were also welcomed by employees.

A significant effort was made to integrate Western's mission into the new building design. An imposing artistic exhibit against a large wall in the entryway displayed renderings of people dealing with disaster situations, pictures of storms and tornados, objects of interest (including a melted plastic coffee pot that was salvaged from a burned-out building), newspaper clippings, and banners that communicated Western's important role in protecting its clients from major calamities. Close by was a large engraved plaque that displayed the company's mission statement (Figure 3) that was created as part of the remodeling strategy.

Figure 3: Western National Insurance Mission Statement

To act with integrity in the service of others.

We will achieve this mission by maintaining financial strength,
and by establishing lasting relationships with people and
businesses who share these attributes with us:

* A passion for business and life

* A desire to serve others in need

* Adaptability to a changing world

* A strong sense of humility and humor

Aspiring to be an "Employer of Choice"

Despite Western's desperate situation in 2001, one of its strengths was its loyal, experienced, and customer-focused workforce. To build on this strong asset, Mary Manley and an employee relations committee met regularly to further improve Western's work environment. Western sought to become an "employer of choice," where high-quality applicants see the company as a highly attractive place to work. Figure 4 shows some of the policies and programs that helped Western in its pursuit to become an "employer of choice."

Figure 4: Examples of Western's Human Resource Benefits/Programs

* High quality health care insurance

* Competitive wages

* Annual bonuses tied to company financial performance

* Friday afternoons off

* 401k retirement plan with a company match

* Cash awards for passing professional certification exams

* 100% tuition reimbursement for job-related courses

* Flexible work schedules

* Long-term care insurance

* Monetary service awards for serving 10, 20, 25 years, etc.

* One day of paid leave per year to volunteer for charitable
organizations

* Charitable events for groups of Western volunteers to donate their
time

Western's culture was especially focused on volunteerism and fundraising, especially for charitable organizations that served disadvantaged populations. Examples of organizations that Western supported included the Red Cross, Habitat for Humanity, nursing homes, food shelves, and homeless shelters.

In addition to giving one day of paid leave per year for employees to volunteer, Western made charitable giving fun. One program gave "Dress Down" stickers to employees who make charitable donations, allowing the employees to dress down at work for a day. Every year during National Volunteer Week, Western held special events to celebrate employees who donated their time and money to charitable causes in the past year. The company itself backed this community commitment by pledging 1% of its annual net income after tax to charitable giving to employee- and agent-suggested non-profits.

Western's new slogan, "The Relationship Company," proved to be a strong anchor for designing programs that build relationships among employees and tie them closer to their communities. Two measures of success in becoming an "Employer of Choice" indicated that the efforts were paying off. First, Western's year-to-year employee retention rate consistently averaged 97%. Second, annual employee surveys showed that nearly 100% of respondents said they would recommend Western to their friends and family as a good place to work.

Technology Upgrades

For reasons of efficiency and customer service, Western needed to upgrade its technology. One of the first major actions to move Western away from its traditional business processes was creating an agent portal for personal lines (home and auto) on its website. This occurred during 2001-2005 and required the implementation of software technology that would permit independent agents to log in to submit applications and get insurance quotes. Michael Braun, Vice-President of Information Services (hired in 2005 to lead IT), pointed to the agent portal as "putting Western on the map" as an up-to-date insurance company in the minds of its agent-customers. Braun also cited the significant savings provided to Western by the portal because agents were now doing the data entry function that Western employees used to do. Having an agent portal that worked well was also critical for building new business relationships. Attracting new agent-customers required "wowing" them with technology that provides faster service, ease, and reliability.

A second major technology project was the Imaging and Workflow Program (IWP) that was implemented in 2005-2006. IWP converted the vast majority of Western's records into a digital format for storing and accessing. Software was implemented to permit most of Western's incoming mail to be scanned and placed into work queues for employees to process at their work stations. IWP changed business processes by eliminating the movement of paper files, and instead moved work instantly to the right people for timely completion. Accuracy and security were also enhanced by these new systems.

Braun praised Western's employees for smoothly adopting the new technologies and embracing new work methods. In contrast to the stories heard elsewhere about employee resistance to changes in the work environment, Western's employees were the key to the successful implementation of IWP.

A third technology initiative dwarfed the first two in complexity and expense. This was the selection, purchase, and implementation of an end-to-end Policy Administration System (PAS) that would link all of Western's business processes and its employees to a single system. In January 2005, the PAS package called "CSC Point In" was purchased. The Point In software provided Western with "a platform-flexible, function-rich system with broad support for all lines of businesses, including commercial lines, workers' compensation, niche and specialty lines" (CSC website: http://www.csc.com).

The Point In package is known as an "end to end" software product because it encompasses a broad range of functions, including claims management, document management, statistical reporting, agency management, fraud detection, business analytics, automated renewals, billing, and legal reporting, among others. Western spent millions of dollars on the purchase and implementation of Point In, but the software proved right for Western's strategic and operational requirements.

A major contributor to the successful adoption of Point In was Western's commitment to acquiring talented people with the skill sets to work through the implementation challenges of the Point In project, and to fully exploit the system's capabilities in the post-adoption phase. For example, Western established a project office to manage on-going information technology (IT) projects, and the data analysis and testing team ramped up from 5 to 15 people as new systems were adopted. These commitments to acquiring and retaining highly skilled IT personnel helped ensure that Western's IT projects provided maximum support to the company's strategic priorities.

Point In also received top-level support from CEO Stu Henderson, who saw Point In as a critical step in Western's future success. He championed Western's IT projects and had the patience to tolerate the expense and uncertainties in adopting these complex systems.

Evolution of the Board of Directors

Between 2001 and 2009, the Board of Directors was reshaped to broaden and deepen areas of expertise. Included among the new board members was a CEO of a nation-wide pension organization, a CEO of a major Twin Cities-based logistics company, a CFO of a large health maintenance organization, a turnaround consultant with CFO experience in the restaurant industry, and a college professor with expertise in operations management. The Chairman of the Board, who had been part of the effort to bring in Stu Henderson as an outside CEO, was a principle in a Twin Cities law firm and a former Speaker of the House in the Minnesota State Legislature.

The diversity of the board changed as well, as two of the new board members were women. Western's officers attend and participate in Board meetings and have noted that the board is much stronger in asking important questions and suggesting ideas for addressing Western's challenges.

THE CHOICE FOR GROWTH: SELL EXCLUSIVELY THROUGH INDEPENDENT AGENTS OR ADD A DIRECT-TO-CONSUMER SALES MODEL?

Selling insurance products directly to consumers was one of the growth options Western was considering. Almost all insurance sold by insurance companies directly to the consumer, whether through the Internet or direct solicitation (mail, phone, etc.) is for personal lines insurance, as opposed to commercial lines. Personal lines include home, auto, umbrella, boat, recreational ATV's, and motorcycles. To date, most companies marketing directly to consumers have achieved success by selling auto insurance. Of the total U.S. pool of property casualty premiums, approximately $170 Billion is collected for auto insurance.

In selling directly to consumers, the main competition that Western would face presently is large national carriers such as Progressive and Geico. While Progressive pursues a dual strategy of selling through both agents and directly to consumers, Geico's strategy is an exclusive one of marketing directly to consumers. In the future, Western might also face other regional carriers such as Acuity, West Bend, State Auto, and Austin, which could develop their own direct to consumer marketing strategies. At present, all regional carriers (of which Western is one) pursue a single distribution strategy of marketing through independent agents.

Selling directly to consumers via the Internet, telephone, and mail was appealing in several ways. It would give Western more control in presenting insurance products to the customer, and offered greater opportunity to control the quality of customer service. Savings on agent commissions was another major reason to sell directly. Limiting the presently dominant role of independent agencies would also reduce the technical challenges of interfacing with different IT systems. Finally, the direct sales model fit well with the well-documented societal trend toward Internet commerce.

Despite the appeal of adopting an Internet-driven sales model, the direct sales model had several drawbacks. First, Western would have to invest in recruiting, training, and rewarding permanent staff to sell its products. While sales expenses were largely variable (paid as commissions) with the independent agent model, more sales expenses under the direct sales model (salaries, benefits, and other personnel costs) would be fixed and occur regardless of sales volume.

Secondly, advertising expenses would rapidly become a significant portion of sales expense because Western would have to promote the Western brand and direct consumer traffic to the Western website. The large national brands, such as Progressive, were much better established and had greater financial resources for advertising to the public.

Finally, it was difficult to differentiate insurance products in a mass marketing environment such as the Internet, where price is often the dominant criterion in consumer purchases. If Western were forced to compete solely on price, it would struggle against its larger competitors.

Alternatively, Western could expand sales by devoting more resources toward building sales through its traditional network of independent agents. A significant advantage of this strategy, was the saving of personnel costs related to maintaining a permanent internal sales force that would be required under the direct sales model. Another advantage was that commission costs paid to independent agents are almost entirely variable and directly tied to sales volume. (The average commission paid by companies marketing through independent agents ranges from 10 to 15 percent. Western writes approximately $60 million of personal auto premium at an average commission of 14 percent. Auto insurance is sold by Western in eight states: Minnesota, Wisconsin, Iowa, South Dakota, Washington, Utah, Oregon and Utah.)

There were several disadvantages of the independent agent sales model. First, agents represented more than one company and Western had little control if an agent decided to present another company's product to a customer. In other words, Western did not have the full attention or loyalty of independent agents. Second, Western did not have ultimate control over the quality of service its policyholders received from independent agents. Customer service was a critical part of policy renewals. Third, at the regulatory level, legal violations by an independent agency could present a liability risk to Western, as well as tarnish its reputation. Finally, in expanding its information technology systems to include independent agencies, Western faced the daunting task of interfacing with a myriad of different hardware and software systems at the independent agency level.

Requirements to Build a Direct-to-Consumer Capability

To begin selling personal lines (home and auto) directly to end consumers, Western would have to build from scratch a new system to enable customers to interact with the company by phone or Internet and be able to switch between those mediums easily and seamlessly. This would require a strong, user-friendly system. The critical elements for building this system are as follows:

Initial Fixed Costs:

Initial fixed costs include $6 million for front-end software costs and interfacing with the existing financial database. This figure includes 60,000 labor hours for developing, testing, and implementing the technology at $100 per hour (a blended rate using in-house resources and outside vendors) and $1.2 million for additional high-end servers. Both of these fixed cost elements would be amortized over five years.

Labor Costs:

Western would have to hire permanent staff to provide customer service for a minimum of 12 hours per day. Assuming that $15 million in premiums can be sold within 18 months of initiating operations, the following labor is required:

* Level 1 employees with skills to service existing policies for changes in address, vehicles, and usage. Eleven employees would be required at a salary and benefits cost of $45,000 per employee.

* Level 2 employees who are licensed agents with skills to actually interact and sell insurance to prospective customers. Four employees would be required at a salary and benefits cost of $65,000 per employee.

* A manager of the "Direct to Customer" program at a salary and benefits cost of $90,000.

* The initial staff would be able to service up to $25 million in premium volume. Each additional $2.5 million of premiums would require another Level 1 employee and 1/4 Level 2 employee.

Additional Estimated Expenses:

Support from human resources, legal, actuary, accounting, and all other support services (not including allocated claims handling expenses) of $955,000 per year.

* Average claim handling expenses of $200,000 on $15 million of premiums.

* Annual software/hardware maintenance and upgrades of $400,000.

* Annual advertising and other promotional expenses of $800,000.

* Claim payments on $15 million of premiums of $9,300,000 (62%).

* Reinsurance costs of $250,000.

Success Defined

If Western decided to add direct sales to its business, it would not want to disturb revenue streams being generated by the independent agents in current states of operation. Therefore, a new direct sales program, if launched, would be established in a new state where Western is not currently doing business. The venture would be deemed a success if within 18 months Western could establish a minimum premium base of $15,000,000. Assuming the average annual premium for an auto in the new state would be $1,428.00 (two vehicles per policy), Western would need about 10,504 policies in force at the end of 18 months.

CONCLUSION

Stu Henderson and his senior management team knew that despite the company's recovery from potential insolvency, the changing marketplace imposed rigorous competitive challenges on Western. Deciding on a future growth strategy was critical.

Staying with the proven independent agent sales approach had its merits, but Henderson knew that recognizing new opportunities and moving away from obsolete business practices was an important part of his job. He didn't want to look back at this time with regrets that he didn't make the right decision.

Michael J. Pesch, St. Cloud State University

David L. Eide, Western National Insurance

Subba Moorthy, St. Cloud State University