The Start-up From Hell
Too bad you couldn't have taken out start-up insurance.
That's what pops in to mind when you hear the saga of Heritage Union Life Insurance, Philip Walker's start-up from hell, the company birth no entrepreneur in his right mind would choose to midwife.
You think your industry is tough? Try breaking into life insurance, a field whose barriers to entry include, in Walker's words, "high overhead, onerous regulatory restraints, and lawyers out the ying-yang." Life insurance comes under the purview of the states, so there is no common application for licensure, and each state raises its own bureaucratic hurdles. Then there's the Catch-22 of getting rated. A.M. Best and Standard & Poor's aren't likely to bestow a top rating to a company without a track record and a colossal cache of capital -- and yet such a rating is nearly essential to getting business and building that track record.
So why this entrepreneurial death wish with life insurance?
"When you're a hammer, everything looks like a nail," says Walker.
Walker, 44, is a consummate data miner. Five years ago, he and a partner who had a similar background embarked on a search for a way to employ their skills in a more socially beneficial field than their former industry, credit cards. "Insurance came to the top of the pile," Walker says. "It's data-centric. It's risk based. It's mass consumer." Taking it further, Walker concluded that life insurance was more straightforward than health or disability insurance and less fraught with cost-management issues and fraud. Moreover, a golden opportunity awaits the company that can tap into a huge unserved and underserved market. According to the Life Insurance and Market Research Association, 2 in 10 American households have no life insurance, and among those that do, 40 percent say they need more. That's 48 million potential customers. Plus, starting a life insurance company would circle Walker back to his first job out of college and to a bit of gnawing, unfinished business.
IT'S ALL ABOUT THE IDEA. ISN'T IT?
Walker's first job, which followed a failed entrepreneurial fling -- the Phil Walker Roofing Company ("I had a lot of strong college friends") -- put him face to face with young couples around their kitchen table, trying to sell them life insurance, in the middle of what he soon saw as "a conflicted sales practice."
"I hated it -- with a passion," he says. "Because the right thing to sell to my customers was not the thing that was going to keep me employed. What I needed to sell to keep myself employed were highly leveraged investments, which I thought were too risky for my customers, and quasi-insurance/savings vehicles, which were too expensive for my clients, who were principally young families." Walker would say, "Bob, if you die, Mary's in trouble. You need the most coverage you can get, but you don't have a lot of money, because you're young like me. So we need to do it the most efficient way possible." He did that regularly for clients. That didn't please his boss. "I was blowing away my term insurance numbers, but I could never make my whole life numbers [which earned commissions that his manager shared in]. My boss kept riding me." Walker lasted less than a year.
"So I went off and took one of two jobs the Bible mentions as unsavory. My parents were glad that it wasn't prostitution," he says. "I went into currency trading." Walker joined Thomas Cook as a trader, ended up running a bunch of the company's divisions, and left in December 1998 for a job at Capital One, the credit card company, where he soaked up all he could. He built a lot of the company's Internet structure and had an insider's view of what was then the biggest direct-mail operation in the country, one conducting as many as 14,000 product tests in a year. Capital One sent Walker to Stanford's Executive Education program. His annual compensation reached $600,000. And in 2004 he left. Capital One, he says, needed to become a bank. He didn't want to work for a bank. What he wanted, now that he knew a thing or two about business, was to head his own business, and something more substantial than a roofing company with a couple of trucks.
Walker and Frank Lortscher, who bolted Capital One with him, started kicking around some ideas for businesses. They drew up a matrix of possibilities: subprime mortgages, collateralized lending, certain types of asset-backed lending -- all risk-based nails for their number-crunching hammers. Life insurance made it to the matrix after Walker realized that, having left Capital One, he'd lost his company-supplied life insurance coverage. He now found himself on the other side of the paperwork, facing an insurance agent "who immediately tried to sell me whole life and universal life policies, which were exactly the types of policies I didn't want to sell when I was a kid."
Walker again agonized over the inherent ills of buying life insurance, which many Americans deem one step up from a colonoscopy, and a small one at that. There's the incomprehensible terminology -- cash value, straight life, continuous-premium whole life, first-to-die insurance, decreasing term insurance. And add-on policy riders. Fine print on top of fine print. And the looming medical evaluation.
"It's the only financial services product where they actually poke holes in you," Walker says, alluding to the de rigueur blood test. "I can't imagine a worse sales process than one that gives you a product you can't understand, that's almost certainly not going to meet your needs exactly, that treats you like you are not being truthful, and at the end of the day pokes holes in you -- and then, having poked holes in you, maybe declines you."
It doesn't have to be like this. It doesn't have to be this complicated, Walker told himself five years ago. All I want to do is make sure if I die, Tonya and the kids would have an income.
And it came to him: Why don't I just guarantee people's income? Wouldn't that be better and much easier for people to understand?
The notion of a new life insurance product and business strategy started to come into focus. That night, Walker sat down and started to model what now goes by the name of SalaryShield. In simple terms, a SalaryShield death benefit replaces the policyholder's income. It is paid monthly, like a salary, rather than in a lump sum, like a conventional term-life policy. "So you never have to worry about it," says Walker. "Unless you have a huge rising income, in which case you can buy additional coverage." (For more on the mechanics of SalaryShield, see "Your Paycheck Comes Home Even After You Don't," page 107.)
"Turns out, once we analyzed it, there are all kinds of reasons to build a product that way," Walker says. "It's better for underwriting, easier to sell, easier to fund, which makes it cheaper and more affordable -- just a whole bunch of things really work together."
And so, in early 2005, Walker and Lortscher launched a company in their hometown of Richmond, Virginia.
ABOUT THAT BUSINESS MODEL...
So where's the insanity in this seemingly better mousetrap? Walker starts pulling arrows out of his back. "We had three hypotheses," he says. "The product would really work. Insurance companies would manufacture it for us. And we'd be able to reach people via direct mail. Turns out only one of those hypotheses is correct."
Consumers did love SalaryShield -- in market tests, they chose it 4 to 1 over comparable products. But manufacturing became incredibly hard. "Manufacturing" is industry talk for all the steps necessary to produce a signed policy. (Heritage Union's is two pages long, one-fourth the length of many term-life policies.) When Walker showed up in 2006 to partner with big insurance companies -- part of his low-overhead model -- offering both his trademarked SalaryShield concept and the backup capital of a highly rated reinsurance company, deal after deal fizzled.
Companies were interested, he says, and he met with all the big players. But the big insurance companies were like sausage factories: No matter what you put in the front end, sausages come out the other end. "Out came your traditional life insurance experience: huge forms, very long applications, and in the end, not very cheap, as it went through the bowels of the organization and each level made a tweak and a change to it. It came out looking like sausage, exactly like one of their standard policies."
As for trying to sell the product themselves via the intended method -- a blizzard of direct-mail offerings, à la Capital One -- that went nowhere. Right about then, postal rates skyrocketed, but fundamental flaws loomed even larger. "My partner and I had just spent five years buried in the largest direct-mail engine in the world," Walker says, "so we figured we'll just sell it via mail." Bad assumption. A well-crafted mailer doesn't move people to buy life insurance; typically, life's events push people to face this unwelcome purchase.
"Life insurance has to be sold. It is never bought," says Richard Wright, a half-century veteran of the industry, a former member of the board of the Life Insurance and Market Research Association, and chairman of the board of Heritage Union. "People don't wake up one morning and say, 'Geez, I need to go out and get some of that good stuff.' People know they need to have auto insurance and home insurance and health insurance, but when it comes to life insurance, there's always been this mystique -- How much? What kind? -- and therefore the role of the agent, someone well versed, comes into play. The saying goes, To sell it, you have to back the hearse up to the door."
Walker retreated, reexamined his situation, and went back to his lead investor, Rick Sharp, to break some most unpleasant news. Initially, it had looked as if $3 million would be enough to launch SalaryShield -- but that was based on an assumption that Heritage Union would operate as an insurance agency rather than as an insurance company. Big difference. "Agencies can sell insurance," Walker says. "Companies manufacture insurance. As such, companies control cost assumptions, underwriting procedures and decisions, product filing, product marketing. Of these, the last was most important to us -- we wanted to speak plainly and compellingly about a very simple product. We learned that the only way that we could deliver a simple product that was also simply described was to build it ourselves. Apparently, simple is hard."
Such is the Sargasso Sea, Walker was learning, that becalms entrants into the insurance industry. In hindsight, he might have been wise to have had someone like Wright on his board from the get-go. When Wright joined the board, in 2008, he was the first member to hail from the life insurance industry. Wright allows that "early on, some of the nuances and operational hurdles of the insurance business" were not fully understood by the Heritage Union brain trust.
Plan B now hinged on buying an existing insurance company -- easier than creating one from scratch. The new, more informed, more realistic start-up infusion? Not another $3 million. Not $6 million. Not $10 million. Sharp, a seasoned pro, the former CEO of Circuit City, founder and chairman of CarMax, chairman of Crocs -- sputtered when he heard Walker say $30 million.
That was not what Sharp had bargained for when he agreed to fund an innovative little insurance agency. And so Walker and Lortscher (who has since left Heritage Union but has a seat on the board) went on the road. They quickly secured the money they needed through a combination of debt and equity -- and at the last minute, the deal fell apart. They went back out. After 30 meetings, they landed the money they needed, mostly from hedge funds and private equity funds.
So here was Walker, nearly two years after founding Heritage Union, having sold a handful of policies, now needing to buy an insurance company. (He also, as a hedge, founded one, in Arizona; that process turned out to be relatively painless.) He identified an acquisition target: Annuity & Life Reassurance America, domiciled in Connecticut. A purchase agreement was signed. For state regulators to OK such a sale, all sorts of specialized functions had to be in place at the acquiring company. Meaning, Walker had no choice but to maintain a staff of operational folks, compliance people, IT and technical people -- at one point as many as 15 employees, waiting for the deal to be approved by the regulatory powers that be.
And what about these employees, who signed on for a ride but were perpetually stuck at the curb? Because though Walker is tanned and fit and adventurous -- his idea of fun is scuba diving with hammerhead sharks -- and though he models strength and preaches perseverance in the workplace, and though the offices of Heritage Union are like a gallery for inspirational plaques, at a certain point it isn't only the boss's mindset that is crucial. Walker needed believers. He had them.
Sean Gorenflo, Heritage Union's IT director, is a believer. A close friend of Gorenflo's died in heavy surf off North Carolina saving his young daughter. Surfers grabbed her from his arms, but he went under and drowned. His wife, with the help of friends, went through every file folder in the house looking for the life insurance policy she assumed must be somewhere. It turned out he had none; the only coverage was a limited death benefit from his employer. "It's been very difficult," says Gorenflo. "They're scraping by. She's in the process of returning to work to support her two children. This is not what her husband wanted for her."
Julia Roper, Heritage Union's vice president of operations, has a story as well. She and her brother grew up as "insurance brats," children of an attorney who specialized in estate planning and life insurance. Both worked in their father's firm, she continuing on to a career in life insurance, her brother moving on to other things but mindful of ensuring that his family would be taken care of should he die. Which he did, unexpectedly, at age 52, leaving a wife with a disability that left her unable to work and two college-age children. His term-life policy paid a sizable death benefit.
There are a lot of ways to make mistakes with a large sum of money, especially if you are grieving. "Within two and a half years, she'd gone through every bit of it," says Roper, "and as a result they've really struggled. The kids had to drop out of school for while. I know for a fact that if a product like SalaryShield had been around, my brother would have bought it, and they never would have been in the situation they were in."
Roper joined Heritage Union in 2006, bringing with her a quarter-century of industry experience. Moving to a small, uncertain start-up wasn't something she undertook lightly. "I had built a very successful career, and I wasn't going to risk my reputation for something I didn't really believe in," she says. "This is something worth putting yourself on the line for."
THE THIRD LEG OF THE STOOL
"We founded a holding company and an agency so that we can have licenses to work both on our own paper and on other people's paper." Walker is talking with Jonathan Miller, the CEO, and Danny Ballard, vice president of training and marketing, for Parsonex Capital Management, an Aurora, Colorado, financial services marketing organization. The meeting is a mutual audition that could result in Parsonex agents selling SalaryShield.
"And then we established an Arizona-domiciled life insurance company called Heritage Union Life Insurance, and then we purchased a company called Annuity & Life Reassurance America and merged those two companies within the last year."
What Walker doesn't say is how agonizingly close that crucial acquisition came to not happening -- how his company very nearly died in Year Four. Again, the problem hinged on the bureaucratic barriers to entry -- in this case, the department of insurance in Connecticut, which had to approve the sale. After months of due diligence to vet the company Heritage Union was buying, Walker and his colleagues had to spend another month assembling countless documents required by Connecticut insurance officials. In October 2007, a letter came from Hartford. It said, in the peculiar language of insurance regulators, that the department of insurance was inclined to turn down the purchase. The letter identified a host of reasons, among them a lack of industry experience at Heritage Union.
Walker was at a new nadir of frustration and anger. But he remained unbowed. "It's one of those things you just have to believe can be solved," he says, "because there's no point in believing it can't." He hastily arranged a meeting, a last-ditch effort to correct some misunderstandings and sell the department on Heritage Union's solidity and mission. On November 1, he and his core team, plus two sets of lawyers, met with the department of insurance's general counsel and representatives from the financial and licensing sections.
The meeting lasted three hours. Heritage Union agreed to bring on a chief financial officer with a strong life insurance background and likewise add life insurance experience to its board. Then it was back to Richmond, to amend the application with more than a hundred pages of new paperwork. That was dispatched to Hartford on December 10th. Public hearings began in Hartford on January 31, 2008, with the clock ticking on the purchase agreement, which was set to expire on February 29. On February 14, the Connecticut department of insurance approved the acquisition, and Heritage Union closed the deal on Leap Day. Finally, 15 months after shaking hands with Annuity & Life Reassurance America, Heritage Union was empowered to sell the product it had readied for market so long ago.
Explaining the rationale behind SalaryShield to the Parsonex execs brings Walker to the conference room whiteboard, where he draws a graph with a curve rising from left to right, representing the increasing chance of death as the policyholder ages, and a second curve sloping downward, tracking the present value of the customer's income replacement need. "Originally we called it adjustable term insurance," he says, "because it self-adjusts."
"Can I draw a picture on the board, too?" asks Ballard, who's already out of his seat. He draws two analogous curves, explaining that when you're young, you need a lot of insurance, and as you get older that need should go down (Curve One). You need life insurance because you have little money saved, but with sound investment strategy, you accumulate the savings over time (Curve Two). "This product is a mirror of the way the investment curve goes up," he says. Parsonex has about 180 agents in five states; they specialize in retirement planning. SalaryShield, Ballard says, offers a fitting front-end financial protection for clients. Just as important, it has a pitch-perfect name and a concept he feels his agents will embrace, what with term insurance becoming more and more of a commodity, bought solely on price. "It's got an energy to create some momentum."
He and Miller are equally keen on SalaryShield's switch from a lump sum payout to monthly payments. "People don't live in lump sums," Ballard says. "None of us gets paid in lump sums. Nobody gets $400,000 and is told, 'You need to live on that for the next 10 years.' Nobody's programmed that way. We're all used to getting a monthly paycheck, making our house payment, our car payment, paying our bills, tithing, whatever we do, and what's left, we survive on that. So this product is matching the way people live."
Less than a week later, after ironing out such particulars as commissions and operational procedures, Heritage Union and Parsonex strike a three-month test deal, and within days, the first Parsonex-sold policy is underwritten -- for Miller's wife.
This deal (which has since been extended through 2010) gives Heritage Union a third sales platform for the fourth quarter of 2009, adding a traditional sales component to a second generation of direct-response TV ads and a fledgling arrangement with Wells Fargo Bank and a major insurance company that thus far prefers not to be named.
Reality check: None of these sales channels is proved. With policies sold to date still in the hundreds, 2009 projections call for a loss of $4 million. The wish, of course, is that one or more of the selling methods will gain traction and start streaming applications into Heritage Union. "2010 is our go-to market year, where we should see the numbers start to turn around," says Walker.
Heritage Union is certainly dreaming big. It hopes, by taking advantage of emerging technology that peruses pharmacy records, to substitute an applicant's prescription history for the need to draw blood, taking the poke out of the process for many. "We're pushing out the limit on how far we can go with nonmedical underwriting, by using some pretty sophisticated technology to both present the application and interpret it on the back end," Walker says. "Our hope is that 70 to 80 percent of the people who apply for the product will get an answer while they're on the phone or the website. Simple as that.
"Ultimately we want to get SalaryShield, either issued by us or by us and somebody else, in the hands of one million families," Walker says, "because that will mean that each year, at least a thousand of those families will not have to change their neighborhoods, will not have to change to different schools, will not have to give up their plans of a future education. I've never heard any life insurance company talk of it this way, but we're in the claims payment business -- everything we do, we're fighting for the right, the privilege, to pay claims."
Fighting, indeed. Asked if he feels a bit like a boxer who has gone 10 rounds in a tough bout, Walker ponders a moment, then subtly tweaks the metaphor. "I see it," he says, "as 10 one-round fights, nine of which I've won."
John Grossmann is a longtime contributor to Inc. and the co-author, with Gordon Hempton, of One Square Inch of Silence, a book about the need to preserve America's few remaining quiet places.
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