Binding Agreement

The binding (or delegated) authority arrangement is set to become more popular as managing agents look for ways to bolster profits and open up untapped markets.

Imaginative brokers can look to take advantage of the changing mindset, setting up a delegated authority arrangement that will give them more control of the underwriting process.

"More business comes into the open market in a hard market, but as the market softens more business gets placed under binding authorities," says one senior Lloyd's underwriter.

Lloyd's insurers such as SVB, Amlin and Beazely are just a few of the businesses that value binding authorities.

"Binding authorities give you distribution and access to income you wouldn't normally get," says SVB chief executive Matthew Fosh, adding that the agreements generate around 10% of the insurer's business.

Binding authorities also offer significant advantages to brokers and their clients, enabling brokers to deal with their clients' requests for cover much more efficiently.

Carroll & Partners has binding authorities from Lloyd's underwriters to write property and liability business. Head of wholesale non-marine division David Ezzard says: "You are able to offer a client an immediate response and you're not trying to second guess what the underwriter might do."

They also enable a broker to which types of business which attract which rates, says Ezzard.

So how might a broker secure a binding authority from a Lloyd's underwriter?

"Provincial brokers could establish a relationship with one of our service companies," says Amlin managing director James Illingworth. "We would then carry out financial due diligence on the quality of the coverholder (the name given to companies holding binding authorities from Lloyd's) and we would look at their record."

Lloyd's managing agents require brokers looking to set up binding authority arrangements to produce their business plan for inspection.

"A broker would have to come along with a proposal and then the underwriter would assess the financial stability of the coverholder and then look at what systems they have in place," says a director of underwriting at a Lloyd's managing agent.

Underwriters place a great deal of emphasis on the auditing of prospective coverholders. This is largely due to the Lloyd's franchise board's cautious approach to delegated authorities, which are estimated to generate just over a fifth (22%) of Lloyd's business.

One managing agent chief executive says the Franchise Performance Directorate (FPD) expects Lloyd's insurers to make it clear which parts of their business are introduced via coverholders.

"The FPD wants you to break down your book into delegated and non-delegated business - if you had a lot of delegated business they would probably question the logic of that," he says.

The FPD's concern about the use of binding authorities relates to the potential pitfalls that underwriters face when entering into such agreements.

The role of the FPD is to ensure that underwriters at Lloyd's assess and underwrite risk sensibly - the use of coverholders makes it more difficult for them to do this. Fosh says: "Binding authority is not as good as direct (underwriting) to control risk."

Consequently, Lloyd's regulations demand that all coverholders must be approved by Lloyd's before they are able to "enter into contracts of insurance or issue documents on behalf of Lloyd's syndicates".

The prospective coverholder is assessed by the Lloyd's broker who intends to place its binding authority at Lloyd's, as well as by the managing agent of the syndicate planning to lead the binding authority. As part of the process, the prospective coverholder must complete a Lloyd's approved coverholder application form, which requests details about:

- the company's staff;

- reputation and standing (for example details about past criminal records of the principal personnel at the company);

- the company's professional indemnity (PI) and errors and omissions (E&O) cover;

- company accounts;

- systems and administration.

Once this process is complete, and providing the coverholder has received the approval from both the broker and the managing agent, the application is then considered by the Lloyd's Coverholders Department, which decides if the applicant is suitable to be added to the list of approved Lloyd's coverholders. The stringent checks carried out on coverholders by Lloyd's are designed to reduce the risk of the coverholder abusing its position.

"A whole host of things could go wrong," says the director of underwriting at the Lloyd's managing agent. "The coverholder could go beyond the binding authority they have."

Indeed, Lloyd's underwriters say the FPD has begun monitoring binding authorities more closely in an effort to avoid problems. "We're seeing a tightening in the latitude and management of delegated authorities and the franchise board has stimulated this," says Illingworth. "We (Amlin) are very careful in our selection of coverholders. We don't reward the coverholder on income, we reward them on performance."

Despite the efforts of the FPD to police binding authorities, some managing agents are very wary about entering into agreements with coverholders.

"We're not big on delegated authority as we don't like giving the power of our pen away," says one chief operating officer of a managing agent.

"You have the danger of a third party breaking your guidelines. If it's a full authority, there are no guidelines."

However, other leading Lloyd's insurers value binding authorities highly.

Beazley writes small to medium-sized business through coverholders. Business lines such as homeowners and small PI policies are written by the insurer via delegated authorities. Such agreements are a valuable source of income for Beazley - approximately a third of its 2003 capacity of £660m was used up by business introduced via coverholders. Beazley director of risk management Nick Furlonge says: "It's a good way of getting business that wouldn't otherwise come to London."

Binding authorities: The pitfalls

While some underwriters view binding authorities as a way of increasing distribution by reaching previously inaccessible markets, others view such agreements as the biggest source of problems in the industry.

JTW Reinsurance Consultants managing director Julian Ward says delegated authority is "enemy number one" of the insurance industry. Ward says that lack of due diligence means that the industry loses millions of pounds each year as a result.

Consultants RW Associates have identified some of the most common problems with delegated authorities:

- authorities that are out of date - coverholders writing business that does not comply with up-to-date terms and conditions;

- cover bound by non-authorised signatories or forged signatories;

- cover bound in excess of binder limits - coverholders claiming that limits have been raised and verbally agreed by the underwriter;

- the rejection of legitimate claims under claims settlement authorities - coverholders in some instances have been guilty of this as they attempt to maximise their cut of profit-sharing arrangements with the underwriter;

- decisions made by non-agreed signatories - the terms of binding authorities often restrict decision-making to named individuals and so should be read carefully by coverholders.