MANAGING YOUR MANAGING GENERAL AGENT
“… the way in which he approached the granting of the binder and his supervision of it was characteristic of the standards prevalent at the time of the Sasse affair at Lloyd’s in the 1970s. He had signed documents without reading them, had paid little attention to the bordereaux supplied and had been prepared to make decisions in wine bars and pubs with no proper notes or documentation being produced to record such decisions as may have been made on such occasions. He had paid no proper attention to the internal controls in place and had failed to conduct any inspection or audit.” 1While the ability to source business through managing general agents (“MGAs”)2 is integral to
the global insurance industry, when MGAs go wrong, they can go spectacularly wrong with disastrous consequences for the MGA’s principals. This paper will review the various stages of the relationship between an MGA and the principal insurer/reinsurer, from negotiation of the underwriting agreement through to termination of the relationship and aims to provide practical guidance, based upon the writer’s own experience and lessons to be learned from some of the scandals that have plagued the industry in recent years.
I THE UNDERWRITING AGREEMENT
A comprehensive underwriting agreement forms the foundation of any successful MGA relationship and should set out, in as much detail as possible, the respective rights and duties of the insurer and MGA. A typical agreement should cover the following:
A. Underwriting Guidelines
The underwriting agreement should describe the class, type, territory, limits, attachments, maximum brokerage and maximum policy period of the business to be underwritten by the MGA
1 Mr Justice Thomas, Sphere Drake Insurance Limited and ors v Euro International Underwriting Limited
and ors, Case No. 2000 Folio 249 (8 July 2003)
2 In London and elsewhere, MGAs are often referred to “coverholders” and the insurer/MGA relationship is variously described as a “facility”, “line-slip” or “binding authority”.
Page 2 of 9 and, to the fullest extent possible, address pricing and selection criteria. The insurer should reserve the right to amend the underwriting guidelines, for example in response to a change in market conditions. Express provision can be made in the agreement for the MGA to seek a “special acceptance” from the insurer where it wishes to underwrite beyond the limits of the underwriting guidelines. The agreement might also identify the particular individual(s) authorized to underwrite the business and manage claims and should contain an express prohibition against sub-delegation of underwriting authority.
B. Agent’s Remuneration
Typically, MGAs are remunerated though a percentage commission on premium income. This formula – which can encourage the agent to write for income rather than for underwriting profits – has been blamed for many of the MGA scandals in recent years. As a consequence, many MGA agreements now incorporate profit commission or risk sharing formulas or even remunerate the MGA on the basis of an annual fee. These provisions need to be carefully drafted and the parties should consider, for example, whether profits are to be assessed before or after reinsurance or how, in the case of longer tail business, reserves are to be valued.
C. Premium Cap
It is advisable that a cap is placed on the amount of income a MGA can assume on behalf of the principal without obtaining further authority. While, for certain classes of reinsurance business it can be very difficult for the MGA to monitor its premium income (for example, because the MGA is in turn reliant on the accuracy of the cedants’ estimates), premium caps could, for example, be based on the cedants’ initial estimates rather than on final earned premium. The insurer might also consider requiring the MGA to notify it once written applicable premium income exceeds a certain percentage of the overall premium limit.
D. Regulatory Compliance
The underwriting agreement should conform to applicable regulatory statements of best practice3
and should specify whether the MGA or insurer has primary responsibility for compiling submissions to regulators4. The insurer should be particularly vigilant in ensuring that the insurer
3 For example, in the case of Lloyd’s syndicates, Lloyd’s Code of Practice: “Managing and Controlling Binding Authority Arrangements” or, in the US, the Managing General Agents Act, NAIC Model. 4 For example, in the case of MGAs operating in the US market, responding to NAIC data requests.
Page 3 of 9 and the MGA are compliant with local licensing requirements5.
E. Trust Account
If the MGA is to be responsible for collecting premium and settling claims, provision should be made for the establishment of a premium trust account. The underwriting agreement should identify the account and set out the limits of the MGA’s authority with respect to payments from the account. The insurer should also ensure that it receives and reviews regular statements for the trust account.
F. Multiple Principals
The underwriting agreement should regulate the MGA’s ability to underwrite for other insurers. The insurer may require advance notice of the MGA’s intention to underwrite for another carrier and the insurer could reserve the right to cancel the MGA’s underwriting authority in such circumstances. This will mitigate the risk of the insurer being exposed to “adverse selection” of risks where the MGA is operating separate facilities for different insurers in respect of the same class of business. Where the MGA is underwriting on behalf of more that one insurer in a “pooling” arrangement (i.e. with co-insurers participating in the same underlying risk), the underwriting agreement should confirm the co-insurers’ respective lines or shares. The agreement should also address the MGA’s authority to use one insurer to “front” risks for the others.
G. Maintenance of Records
Insurers might wish for the underwriting agreement to state the MGA’s responsibilities with respect to the maintenance of records and underwriting data. This could include underwriting notes, placement information, risk lists, accumulation data and triangulations. The availability of such records will greatly assist the insurer in monitoring and auditing the MGA.
H. Reporting
5 In England, one consequence of an unauthorized insurer engaging in insurance business is that the insurance policies are illegal (being written in contravention of the Insurance Companies Act 1982) and are therefore potentially void and unenforceable.
Page 4 of 9 The underwriting agreement should state clearly the MGA’s reporting responsibilities to enable the insurer to have an accurate and current record of premium and claims. The MGA might be required to report electronically to enable closer control by the insurer. The format of the premium/claims reporting should be agreed in advance by the insurer to ensure conformity with the insurer’s own systems.
I. Marketing
The insurer may wish to retain control over the content of marketing materials issued by the MGA, including pre-approval of the MGA’s website. If so, an appropriate provision can be inserted in the underwriting agreement.
J. Jurisdiction and Arbitration
Frequently, the insurer and the MGA are located in different jurisdictions. To avoid disputes as to the governing law of the underwriting agreements, the parties should negotiate and record an express choice of governing law. To avoid the airing in public of potentially sensitive or embarrassing information, insurers may wish to incorporate arbitration clauses in the underwriting agreement.
II UNDERWRITING AND REINSURANCE
A. Letters of Authority
Prudent brokers will generally wish to see some evidence of an MGA’s authority before they agree to introduce business to the MGA. Rather than disclosing the underwriting agreement – which may contain confidential information of no concern to the broker – insurers often issue “to whom it may concern” letters setting out the parameters of the agent’s authority. It is advisable for such letters to be sent to all brokers with whom the agent transacts business as, if the MGA later exceeds its authority, the broker may be deemed to have known of the limited nature of the MGA’s authority and the insurer will not be bound to the risk in question. As a practical matter, letters of authority should contain an expiration date otherwise the authority could be understood to last indefinitely. If the insurer discovers that the MGA has exceeded its authority, the insurer should disown responsibility at the earliest opportunity otherwise the insurer will be at risk of
Page 5 of 9 having ratified the MGA’s actions6.
B. Principal’s Countersignature
While it may be impractical for certain, higher volume classes of business, the principal could require that its signature be placed on all contracts before the risk is deemed bound7. This
requirement could be communicated to prospective insureds in the MGA’s letter of authority. C. Purchasing of Reinsurance
The underwriting agreement will typically specify whether responsibility for purchasing reinsurance lies with the MGA or insurer. At least as regards Lloyd’s syndicates, the syndicate will be expected to satisfy itself as to the adequacy of the reinsurance arrangements irrespective of any assignment of responsibility to the MGA8. Where the MGA is authorized to purchase reinsurance, the insurer may nevertheless consider it prudent to review the reinsurance placement materials to ensure the integrity of the presentation. If, for whatever reason, the MGA’s reinsurance programme is declared void, this could have a disastrous impact on the account’s net loss ratio9. While there is obviously a limit to the extent to which it is practical for an insurer to look over the MGA’s shoulder, the purchase of valuable reinsurance protection is one area where this is justified.
D. Reinsurance Security
6 For example, in Suncorp Insurance & Finance v Milano Assicurazioni Spa [1993] 2 Lloyd’s Rep 225, it was held that, as the reinsurer had been aware that its MGA was using it as a front for co-insurers but had failed to object to the practice within a reasonable period, the reinsurer had ratified the contracts. 7 This approach protected the reinsurer in the US case, AIU Ins. Co. v. Unicover Managers, Inc., Nos. 3784,
3785, 2001 N.Y. App Div. LEXIS 3593 (1st Dep’t Apr 10, 2001).
8 “Where reinsurance cover is deemed necessary to protect the binding authority, the reinsurance cover should be in place before the inception of the binding authority and due consideration should be given to reinsurance which matches the risks which are to be accepted under the binding authority”, Lloyd’s Code
of Practice: “Managing and Controlling Binding Authority Arrangements”
9 In Reliance Ins. Co. v Unicover Managers, Inc. No. 00 Civ. 0791 (LLS) (S.D.N.Y. Jan 4, 2001) the MGA omitted to tell its principal, Reliance, about the breakdown in its relationship with its reinsurers. Had Reliance taken it upon itself to meet with the reinsurers before committing to the facility, these problems may have became apparent.
Page 6 of 9 Insurers should always ensure that reinsurers proposed by the MGA are limited to those on the insurer’s list of acceptable security.
III CLAIMS
A. Claims Authority
Careful consideration needs to be given to whether claims should be handled by the MGA, the insurer or by a third party administrator (“TPA”). Insurers should be particularly alive to the risk of claims overpayment in circumstances where, for example, an MGA wishes to curry favour with a particular producer of business or where the MGA has a financial interest in an adjusting company. The parties should also agree in advance whether the MGA is permitted to make ex gratia claims settlements without approval from the insurer.
B. Reserves and Claims Monitoring
If claims are to be handled by the MGA or by a TPA, the insurer should ensure that claims are handled and reserved in accordance with the insurer’s claims handling and reserving philosophies10. In addition, the claims process will need to be audited (see below) and otherwise monitored by the insurer, perhaps though internet-based “real time” monitoring systems. C. Adjusters
If claims handling authority is not retained by the insurer, the insurer should nevertheless take an interest in the panel of adjusters used by the MGA or TPA and may insist on all external adjusters being pre-approved by the insurer. It is advisable for the insurer to ensure that contracts with TPAs are made directly between the MGA and the insurer.
IV AUDITS
A. Scope and Frequency of Audits
10 In the US, failure by the MGA to settle claims in accordance with States’ Unfair Claims Settlement Practices Acts could expose the insurer to bad faith claims and punitive damages.
Page 7 of 9 Typically, audits of MGAs will address underwriting, claims, processes and service standards and will involve sample audits of individual underwriting and claims files as well as targeted reviews of particular files identified by the insurer’s underwriting and claims personnel. Whether carried out in-house or outsourced to external auditors, audits represent a significant cost to the insurer who will, understandably, wish to keep the number of audits to a minimum. One approach is to carry out an extensive audit on, say, an annual basis with more routine audits on, say, a quarterly basis.
B. Internal or External Auditors?
Most larger insurers have in-house audit teams capable of conducting both routine and specialist audits. While in-house auditors will often be best placed to understand the insurer’s expectations of the MGA and may be better placed to offer continuity, there may be occasions where the retention of outside auditors is advisable. For example, where litigation appears likely, the situation usually justifies retaining specialist lawyers who have expertise in compiling evidence and are able to conduct their investigations under the protection of privilege. Likewise, the retention of outside auditors or forensic accountants will assist in the preparation of evidence for use in subsequent litigation. It may also be advisable for the role in the audit process of the insurer’s “relationship person” to be passive, particularly where the relationship with the MGA is close and/or if the individual has a significant personal stake in the success of the MGA relationship.
C. The Audit Report
A clear concise audit report is an invaluable means of monitoring an MGA’s progress. The report should be clearly structured with separate sections for underwriting, claims, process etc. and should contain a conclusions and recommendations section. Audit reports are often provided to the MGA to enable the MGA to address any areas of concern and to give the MGA an opportunity to make representations to the insurer. Subsequent audit reports should address changes in the MGA’s performance based on the conclusions of earlier reports. Insurers should consult their lawyers before disclosing privileged audit reports to the MGA and, where audit reports are not protected by legal privilege, insurers should be mindful that such reports could be discoverable in litigation with cedants or reinsurers.
Page 8 of 9 In a subscription market the responsibility and cost of conducting audits is often assumed by the lead insurer, with the following market benefiting from the leader’s monitoring of the MGA relationship. If a lead insurer wishes to share the cost of external auditors it could negotiate for a pro-rata sharing of auditing costs in the underwriting agreement or in a side agreement regulating the relationship between co-insurers.
V TERMINATION AND RUN-OFF
A. Termination Clause
Although termination clauses typically provide for a period of notice, in practice if the insurer wishes to immediately withdraw authority, the MGA cannot continue to bind the insurer (though the MGA may have a damages claim against the insurer). Especially where the US market is concerned, the insurer should consult its legal advisors on its ability to withdraw capacity from a particular market.
B. Publicizing Termination
Particularly when a MGA’s authority is revoked in circumstances where there are concerns about the nature of the business assumed, it is advisable for the insurer to publicize the withdrawal of authority, by writing directly to insureds and producing brokers and perhaps by advertising in an insurance industry journal.
C. Claims Run-Off
Underwriting agreements are executed at a time when the parties are optimistic that the relationship will prove to be successful one. It is therefore unsurprising that the parties often fail to consider post-termination issues, such as the handling of run-off. For example, will the insurer want the MGA to run-off claims if the relationship has deteriorated to the extent that the MGA’s underwriting authority has been revoked? On the other hand, if the MGA’s fee is in part consideration for the MGA’s claims handling services, is it fair that the insurer will have to assume the additional cost of administering claims? These issues should be worked out in advance.
Page 9 of 9 If the MGA relationship breaks down due to high losses, litigation with insureds and reinsurers often ensues. In these circumstances, the services of MGA personnel, as witnesses and consultants, could be vital. The insurer should, at the earliest opportunity, arrange for relevant MGA personnel to be interviewed by the insurer’s lawyers and relevant documents should be isolated. Where appropriate, consultancy contracts should be negotiated with key personnel.
While it is hoped that this paper will have provided general guidance on matters to be considered throughout the MGA relationship, it is not intended as a substitute for individual legal advice tailored to any particular MGA relationship.
MARK CHUDLEIGH - 20 AUGUST 2003
Mark Chudleigh is a partner in Sedgwick, Detert, Moran & Arnold's London office. His practice focuses on insurance/reinsurance issues involving all classes of business and he frequently represents insurers and reinsurers in matters involving multi-jurisdictional issues. Mr. Chudleigh may be contacted by e-mail at [email protected], or by telephone at 44.20.7929.1829.
