Cedents Can Protect Themselves From Disastrous MGA Relationships

Insurers, which want to generate premium volume quickly in a new line of business by capitalizing on the purported expertise of the MGA, are often eager to hand over their pens to the MGA, and to cover themselves with reinsurance.

If the insurer fails thereafter to provide the necessary supervision of the MGAs operations, the results can be disastrous for both the cedent and the reinsurers.

In many cases, both the experience and the staffing of the MGA are woefully inadequate and the inattentive insurer does not realize that there is a problem until it is too late. Unfortunately, given the lag time between the underwriting of risks and the realization of the losses, companies often find themselves in this predicament and get burned by the business flowing from the MGA.

Because they generally bear none of the risk on the programs they underwrite, MGAs face an inherent conflict of interest–adhering to sound underwriting guidelines and writing only quality business versus earning commissions on the volume of business they are able to write.

As noted in the Congressional report "Failed Promises" in 1990:

"The use of managing general agents by insurance companies to write business on their behalf is an industry practice that can be exceedingly dangerous. In the worst cases, an insurance company hands over responsibility for its business to the MGA, granting the agent power to underwrite business, obligate the company, handle claims and even arrange for reinsuring the business written by the MGA in the companys name."

"Such a complete delegation of authority would be dangerous by itself, but the problem is compounded by the fact that MGAs are compensated by commissions on the amount of business they write," the report said.

"There is an inherent conflict for MGAs between writing quality business and earning commissions on the volume of business written," the report added.

Some of the most notorious MGA debacles in recent years have occurred in the workers compensation carve-out business. Many international reinsurers, particularly life insurers, looking to enter U.S. proportional markets have been burned by cedents using incompetent MGAs.

In many of these instances, the MGA has contributed to the creation of "spiral" business by placing reinsurance with the limited number of companies with which it has an established relationship. In spirals, the reinsurers then cede their assumed risk to insurers or reinsurers earlier in the claim chain and the reinsurers end up taking on the same risk as retrocessionaires.

Another sticky situation arises when an MGA sits at the hub of the wheel and contracts to protect the insurer with various reinsurance pool members (which make up the wheel spokes). When these pools are not properly documented by the MGA, there is often no wheel (contract) to connect the spokes (pool members) with each other.

In this situation, which may be compounded by poor record keeping, dispute resolution is chaotic. Although there may be separate agreements (with arbitration clauses) between the MGA and each pool member, there is typically no mechanism for bringing all of the reinsurer parties together in a single legal proceeding to determine their rights.

Despite the pitfalls of doing business with an MGA, an experienced and competent MGA can be quite valuable to an insurer that is striving to generate profits in a new arena.

For those insurers contemplating doing business with an MGA, they would be well advised to heed the following:

Conduct thorough due diligence on the MGA (without violating applicable regulations or antitrust laws).

Such due diligence would include reviewing the results of other programs run by the MGA and verifying the qualifications and experience of the MGAs underwriters and claims staff.

Also, its important to verify that the MGA maintains adequate capital to satisfactorily perform its obligations, document the existence of sufficient underwriting and claims guidelines, and assess the adequacy of the MGAs business and marketing plans.

Provide close supervision of the MGAs activities. Conduct frequent underwriting and claims audits and follow through on all recommendations resulting from those audits.

Obtain a warranty that the MGA has sufficient errors and omissions coverage to meet the volume of the business written. Because MGAs generally carry only $1 million-$5 million in E&O coverage, ceding insurers can be left to bear significant losses in cases where the reinsurers rescind their treaties based on an MGAs acts or omissions.

Ensure that the MGA has obtained and maintains the requisite licenses in all jurisdictions in which it operates.

Use a carefully drafted MGA agreement that complies with the National Association of Insurance Commissioners model Managing General Agents Act and the model Reinsurance Intermediaries Act, as appropriate.

It is imperative that the agreement detail the scope of the MGAs authority, without ambiguity, and leaves no room for discretion absent the insurers approval. If there is a pool situation, the agreement should also contemplate a single dispute-resolution mechanism that encompasses all of the parties.

Sally Agel is an attorney with the law firm Milbank, Tweed, Hadley & McCloy in Los Angeles. She specializes in litigation on behalf insurers and reinsurers.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, September 21, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

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