Insurers must be wary of giving the pen away

Every litigating lawyer and restructuring professional in the insurance industry understands what a managing general agent (MGA) is, often summarising it as “a licence to print money”.

The insurance industry in London is in the throes of eradicating the problems which MGAs have caused in the past. Poor drafting and the non-alignment of interests have historically led to many insurers incurring significant losses from their forays into the MGA field. But, today we have what seems to be a monthly announcement of another MGA being formed, often as an adjunct to an existing broking business.

The key question is whether history will repeat itself with insurers again suffering the results of indiscriminate underwriting in a chase for additional business volume?

Over the past 10 years a number of strong new underwriting agencies have emerged and some of these, including Towergate’s Fusion, UK Underwriting and Primary Broker Services, have developed into established businesses handling significant volumes of premium. However, over the past few months we have seen the emergence of newcomers announcing their MGA plans including some of the larger brokers such as Willis, JLT and Giles among others.

So what makes an MGA so attractive?

From a client perspective, an MGA can provide access to experienced and specialist underwriters. The ‘one size fits all’ criteria so often applied by insurers can be replaced with a detailed and intimate knowledge of what a client needs.

From a placing broker’s perspective, the MGA can provide a market for those difficult to place risks where the insurer has insufficient knowledge or desire to underwrite in a niche area. It also provides a cost-effective way to market and a strong level of commission.

From an insurer’s perspective, the existence of MGAs allows it to focus on its core lines of business, while jointly venturing with MGAs for niche lines of business. In addition, where it is seeking to grow a new account, an MGA allows it to develop volume without the need to staff up in advance of business flowing.

Clearly, all parties can win but history has shown that in the absence of a strong control environment it is often the insurer that will suffer.

The drivers for this recent trend of setting up MGAs can vary between the desire of:

“It is not the level of commission paid which decides whether an MGA will be successful, but the quality of business underwritten and the control of the insurer.

• Brokers and insurers to build specialist niches which are less open to competition.

• Brokers to participate in the profitability of a controlled book of business via the receipt of profit commissions.

• Brokers to control more of the value chain by taking on some of the functions of the insurer, thereby allowing an insurer to transfer more of its costs on to a variable basis.

• Brokers and insurers to refresh wholesale models with greater levels of technology, thereby reducing transaction costs.

• International brokers to avoid some of the restrictions placed on how they can earn their income, as a result of the Spitzer investigations in the US, by operating as an MGA where they are in effect a tied-agent of an insurer.

Insurers appear to have woken up late to the impact an MGA can have on their business and on the costs of doing business. Over recent weeks we have seen debate over what is an appropriate level of commission for an MGA. Who ultimately will win this debate may depend on whether the soft market continues and which insurers are seeking to build their books of business prior to rates hardening.

This raises the question of whether the operation of MGAs is a cross-cycle strategy or a phenomenon of a soft market. In a soft market insurers frequently look outside of their core business lines to maintain top line premium growth. Giving the pen away to an MGA can provide a cost effective route to market, utilising a variable cost base. However, as the market hardens, insurers tend to allocate their capital towards their core lines of business and, as such, specialist niches receive less attention. In such an environment MGAs become a cost effective route to market, provided they can demonstrate the underlying profitability of their book of business.

With the current vogue towards establishing MGAs, both brokers and insurers would be wise to heed the lessons of the past. For every successful MGA established there has been another that has ended in tears. It is not the level of commission paid which decides whether an MGA will be successful, as this will find its own equilibrium, but the quality of business underwritten and the control of the insurer.

The lessons of the past are there to be learned and can be easily avoided if both brokers and insurer interests are adequately aligned.