MGAs Urged To 'Put Skin In The Game' By Forming Captives, Despite Soft Market

Illustrating just how soft the reinsurance market is–both for MGA captives and groups of individual insureds–Mr. Packard said he just put together a group captive for seven truckers with "phenomenal" terms.

"We wound up with a quota-share reinsurance mechanism–both on working layer and excess," he said, contrasting the quota-share structure to an excess-of-loss reinsurance structure, which would be less advantageous to the insured.

With a 35 percent cession, he said, "it was a no-brainer to do the deal," adding that he helped set up five captives in the first quarter alone–fueled by access to incredible reinsurance pricing and terms.

As for MGA captives, he noted, "if you said 'MGA' to reinsurers three years ago, it was an obscenity. Now, [the reinsurers] are back saying, 'Let's get back into programs.' And carriers are driving that, too."

Mr. Packard said one thing reinsurers still take a hard line on is that captive owners need "to put skin in the game."

In other words, carriers giving underwriting authority to MGAs sometimes require them to share risk through sliding-share commission arrangements–but for reinsurers this isn't always enough, he said. Explaining how a slide can work, he said a carrier might give an MGA a 5 percent minimum commission and increase it to 9 percent if experience is good.

"A lot of reinsurers now say a slide is not taking risk," Mr. Packard said. "True risk is taking risk on the books–utilizing captives. They won't reinsure an MGA unless that MGA is taking risk," he asserted.

Mr. Packard and other experts tried to sell MGAs on the idea that they should want to get in on a piece of the profit action.

"MGAs, if they're smart, will start to ask, 'How do I get revenue other than the commission on the front end?'" Mr. Packard said.

During his university class, he presented an example in which a $2 million book of business was designated for a captive, with $1.3 million of the premiums ceded to it (after expenses of 35 percent), generating nearly $500,000 in profits for the MGA that would have otherwise gone into the insurer's coffers–roughly $200,000 of investment income (at an assumed interest rate of 5 percent) in six years and a 50 percent loss ratio generating a $300,000 underwriting profit.

"If the carrier is willing to take risk on that business, then why wouldn't I want to? If they're making money from an underwriting standpoint, why shouldn't I take a little risk and get it back?" he asked.

He also urged MGAs to consider setting up captives now "to prepare for the future, because eventually that [hard] market is going to happen," noting that trying to set up a captive in a hard market will be difficult because fewer carriers will want to front the primary coverage, and reinsurance costs will jump.

"The other question you have to ask yourself is whether your book of business is making money in a soft market from an underwriting standpoint. If the answer is yes, then it's going to make even more money in a hard market, and that's what the carriers are counting on," he said.

Chris Kramer, senior vice president and captive manager for Roundstone Insurance in Westlake, Ohio, at one point read off a list of salaries of Bermuda insurance executives in an attempt to convince MGAs to take a piece of the profit pie.

He also read off figures from a Guy Carpenter survey published last year that revealed program insurers not only expect program administrators to produce, rate, quote and bind business on their behalf, but also expect 90 percent of the MGAs to underwrite as well as service and issue policies. An increasing percentage of insurers also expect loss control and claims administration services, he added.

"You're doing the underwriting. You're doing the claims. You're doing the binding. You're doing everything. But [the carriers] are going to make the underwriting profit," Mr. Kramer said.

Beyond that, he reasoned that MGAs can retain valuable employees and retail agents by giving them some ownership in captives.

"The admitted market is coming and taking your business," he said. "That means your production staff is not going to get that bonus at the end of the year."

That being the case, he asked, "How are you going to keep that underwriting manager from taking two or three colleagues and going down the street [to find] deeper pockets?"

"MGAs are always trying to innovate–to find a solution. That is the hallmark of an MGA," he continued, suggesting that the innovative solution of making that manager a part of the captive will also give the employee skin in the game.

"Each year that program becomes successful on your terms, not the market's terms, he's going to make money," he said, suggesting this provides incentives to underwrite the program book conservatively. In the years when it's a struggle to get a front-end production bonus, the manager can get a back-end profit bonus just as easily, he added, describing this as putting "golden handcuffs" in place.

MGAs attending the conference, however, were not easily convinced to jump on the captive bandwagon. They voiced concerns ranging from not having the right data to evaluate captive feasibility to simply being uncomfortable with risk taking.

Len LoVullo, president of Buffalo, N.Y.-based LoVullo Associates and a former AAMGA president, said that "the only way this will work is if I identify one of my best programs and move it into a captive. Then I'm going to be competing with my markets. I've got great relationships with my companies. Do I want to do that?"

"It's an overall philosophy–do you want to take risk or don't you?" he continued. "We're in the MGA business because we don't want to [take risk]. We're agents. If you want to take risk, it's a separate way to think and approach your business. I don't know if I'm ready for that. It doesn't matter who we hire or how much talent we bring in. I'm not sure I want to do that."

Mr. Kramer said MGAs don't have to move entire books into captives, instead learning to take risk slowly by moving only limited amounts of business initially.

But "if I'm the carrier, then I'm going to ask if I am being adversely selected against. Are you moving your best business and leaving me with the rest?" Mr. Packard said.

He suggested that MGAs can walk this fine line by telling carriers they're simply hedging their bets by "not putting all my eggs in your basket," and "that both carriers [the insurer and captive] have the same quality of business."

He also said carriers should see this as a learning experience for MGAs who want to take risk and be prepared "in case markets change and I have to have another answer."

In a separate interview, Scott Reynolds, president of the specialty underwriting division of AmWINS, based in Charlotte, N.C., said his firm doesn't like to compete with its insurers.

"We go to insurers for capacity. We don't want to compete with them, just like our client is the retailer and we don't want to go directly to the insured," he explained.

"We like to keep our model very clean," he said, adding that AmWINS does have a couple of alternative-risk structures in place "that are certainly not typical, because we're not a risk taker."

"If we had an opportunity to move [those] programs to something more traditional, we would," he said, noting that the alternative structures were put in place when carriers did not have an appetite for smaller opportunities and difficult classes.

Asked about the general notion of setting up captives to seize greater shares of underwriting profits, Mr. Reynolds said "agents or insureds that want to get into a captive structure certainly should explore it, but they should be cautious."

"There certainly is the upside of having a very good underwriting year and being able to take additional profit. On the flip side, there's also the very real possibility of having a bad year [and] reducing your income, perhaps dramatically–perhaps wiping out all your income to nothing."

"You've got to be careful and structure it in such a way that you know what your downside risk is," he warned.

Mr. Reynolds said he believes that if there's a reasonable risk appetite for MGAs to get their programs insured in the traditional market with reasonable rate structures, "that is the preferred way to go."

Offering a program insurer's perspective, Detlef Steiner, chairman of Delos Insurance in New York, said he would rather pay MGAs decent profit-based commissions to give them skin in the game than to work with MGA captives.

"There is no skin, because these captives are capitalized with very thin capital. Once something happens to them, that captive is gone," he said.

"Why would I request [that my] reinsurers be first-class, 'A' or 'A-minus'- rated, and then do business with an unrated small capital captive? It's stupid," he said.